Shutting Down the Hotel or Resort Until the Good Times Roll: Is It Really an Option? Alert - July 30, 2009
Shutting Down the Hotel or Resort Until the Good Times Roll: Is It Really an Option?
July 30, 2009
Lynn K. Cadwalader- San Francisco
James M. "Jim" Norman- Ft Lauderdale
If you are of a certain age, you remember the noxious smell of mothballs and the pleasant smell of cedar planks in closets holding winter clothes, waiting for the change of seasons. Can this “mothball” concept work for hotels or resorts whose operations currently suffer operating losses, even during the high season, because of the state of our economy, with its low occupancy and downward pressure on room rates?
Simply put, does it make sense to consider suspending operations while waiting for the economy to recover and have hotel and resort ownership and operations be profitable for all the stakeholders? As with so many things, ideas seem better when superficially considered than after a careful analysis.
There are practical and legal challenges that must be carefully considered when entertaining this option. This article points out areas that will generate costs – in some cases very substantial costs – in each phase of suspension of operations and re-opening of the hotel or resort. In doing so, the point of view of, and impact on, each of the stakeholders is essential and unavoidable. While counterintuitive, a permanent closure or suspension of operations is an easier analysis than one that is temporary. In a permanent closure situation, you quickly end up with a foreclosure, turn-over of the property and loss of the brand. The parties may well become familiar to the bankruptcy court. The value of the property declines precipitously and becomes an asset attractive only to a “bottom fisher.”
What is different about the current economic downturn is that most hotels and resorts that are now being hit hard by low occupancy levels and decreased ADR, GOP, NOI (and the rest of the accounting alphabet soup), were performing just fine until the end of 2008 when the global economy began its downward spiral. No one knows when the hospitality industry will start to recover and when the economy will be back to what would be considered a normal operating environment.
Temporary Closure: Analysis and Impacts
This article will be published in two segments. In part one, we will analyze the option of temporary closure under the key document governing hotel operations – the hotel management agreement. We will also consider the effect of temporary closure on employment issues, local zoning and project entitlements, as well as the impact that temporary closure may have on adjacent projects and in the community where the project is located.
What the Hotel Management Agreement Says (Or Does Not Say)
As with most issues relating to the operation of a hotel or resort, the first document to consider is the hotel management agreement, which reflects the owner-operator contractual rights and obligations. The companion subordination, non-disturbance and attornment agreement adds the rights and obligations of the lender and operator that become effective in the event of an owner default.
With exhibits, a complete hotel management agreement with a brand manager will likely be a 100-page document. The current versions of these documents address every business and legal issue that either the owner or operator can think of. Every major owner-operator court case has been “drafted around.” Industry experience is clearly reflected in these numerous pages.
For all of that, the issue of temporary closure or suspension of operations, either partially or totally, because of severely negative economic conditions is never discussed outside such circumstances as casualty, condemnation and major renovation, expansion or CapEx program. It seems likely, however, that newly drafted management agreements will now specifically address temporary closure (and the process for re-opening) based on economic conditions – this is a good thing.
An exhaustive discussion of all potential provisions that may begin to appear is beyond the scope of this article, but several elements would be essential. These include:
- a definition of what would constitute a downturn or set of conditions that would or might permit a suspension of operations
- the process for finalizing a decision to close on a temporary basis
- the process for determination of the initial duration of the suspension
- the basis for determining that the property should be re-opened and the responsibilities of the various parties in connection with the re-opening
- a dispute resolution process
- how the status and term of the hotel management agreement will be affected by the temporary suspension, including fees for reduced levels of management in order to protect the property through required and preventative maintenance; one example would be a resort abandoning landscape maintenance, including the golf course
Although suspension of operations will stop the project revenue stream and drastically reduce project expenses, it may not stop contractual obligations under vendor and similar agreements or government requirements relating to code compliance or development agreements.
Employment Considerations
Employee issues and expense are major considerations in an operating hotel or resort. Among the considerations for a temporary closure decision, these issues are no less critical.
Laws and regulations that must be reviewed are the following:
- federal WARN Act
- state WARN acts (includes California, Massachusetts, Michigan, New Jersey and Maryland)
- National Labor Relations Act
- federal COBRA Act
- state COBRA acts
- state laws on severance
- federal and state anti-discrimination laws
- ERISA and other employee benefits laws
- tax issues relating to deferred compensation
- immigration laws relating to temporary work visas and return transportation costs
Collective bargaining agreements, particularly in certain states such as California, may create greater barriers to suspension of hotel operations and reductions in force than any agreements between or among owners, operators and lenders.
Local Zoning Requirements and Development Entitlements
Development of hotels and mixed use projects often memorialize the project’s governmental development entitlements, high-level approvals and concessions in documents with titles such as: development agreement, development and concessions agreement, heads of agreement or regional impact agreement (“development agreements”). Development agreements set out the requirements and conditions of the approvals granted by the applicable state and local governmental authorities. These requirements may include obligations to construct specified square footage of retail and commercial space and may include specific requirements such as mandating one or more five-star restaurants; obligations to provide specific unit mix and size (for example, “x” number of residential units, hotel units, employee (below-market) housing units); infrastructure requirements such as parking, roadways and utilities (which may include LEED certification or other green requirements); and quotas for employment of locals. Convention hotels supported, owned or sponsored by government will likely have a myriad of other requirements from “Little Davis-Bacon” provisions to room rates and the control of the parking concession.
So, how does a temporary shut-down of the hotel or resort affect these governmental obligations? First of all, the continued effectiveness of the development agreements (including certain critical concessions such as tax and custom waivers that impact saleability of units) and unissued or in-progress development permits (to the extent the resort is not fully built-out) will likely be affected, even to the extent of creating an event of default that terminates all or certain provisions of the development agreement. This means that not fulfilling these requirements may result in a loss of the developer’s ability to continue with the development of further phases of the project. Further, such a breach of these agreements may precipitate an attempt by government to revoke the operating permits of the hotel or resort and/or sue the developer. As such, critical to any temporary shut-down is a review of the developer’s rights and obligations under these development agreements and attempting to obtain the consent of governmental for the shut-down. When weighing the option of a temporary shut-down with the likely outcome of a permanent shut-down if the project fails, it is not uncommon for the government to work with the developer to extend times for compliance by the developer with its development obligations, although this may come at a cost of additional requirements and governmental involvement. As a key component of the basis for government concessions for the development of hotels and resorts is the generation of jobs and revenue such as sales taxes, transient occupancy tax, and, in the case of units of real estate, transfer taxes, the “temporary shut-down” plan brought to the government should take into account replacement of lost jobs and tax revenues.
An evaluation, under local law, of whether a temporary shut-down of the project would be considered “abandonment,” triggering a host of remedies available to the government, is essential.
Ripple Effect on the Larger Project or Resort Community
Another factor to consider in evaluating a temporary shut-down of a key project within a development zone or a key component of a larger project, is the ripple-effect this action may have on other projects within the development zone or on other elements of the larger project. This is particularly true in the mixed-use setting, where a synergistic relationship among projects exists. For example, the project may have a golf course or other recreational amenities such as a spa, swimming pools, beach club or ski mountain, the maintenance and operational costs of which are shared, at least in part, among projects within the resort community or development zone, with the lions share of the cost typically borne by the hotel. Similarly, in an urban mixed-use project, infrastructure costs such as parking, roadways and even structural and mechanical elements of shared structures involve significant shared costs, which without a hotel component to share these expenses, may make the operation of these shared facilities unworkable. Particular consideration should be given to ensuring that a “skeleton crew” remains to manage and operate certain portions of the shared facilities, which will include a minimal budget in order to minimize the impact on other project components. The cost of full hotel operations (with some revenue generated from operations) against the cost of paying the hotel’s share of maintenance and operation (perhaps on a pared-down basis) of key shared facilities while the hotel remains closed cannot be ignored.
Lastly, the hotel component of a mixed-use project is the densest use within the project and is critical to maintaining the joie de vivre, “open all night” ambience. With this key element lacking, the project may fall flat. As such, analyzing all of the project elements and determining how a shut-down will affect the overall atmosphere of the project is important. It may be that there other hotels in close proximity to the project that may help in providing this missing ingredient during the hiatus period, but that could create a competitive disadvantage in the future when the hotel is reopened.
Additional Considerations – Stay Tuned for Part Two
While at first blush, an operating hiatus may seem an obvious solution during a period of year-round operating losses, given the inescapable fixed costs and the great number of direct and indirect stakeholders whose interests must be considered, a temporary shut-down is anything but simple. However, it’s best to test the water further before jumping in and consider the interests of the key stakeholders who must be onboard with the plan – the main players being the lender(s), the hotel operator, and the owner(s) of the hotel and other major portions of the project or resort community.
In part two of this article, we’ll discuss the interests of, and inter-relationship among these stakeholders, and the key practical and legal considerations of these parties in negotiating a temporary shut-down of operations under their operative agreements – the hotel management agreement, loan documents, development agreements and ownership entity documents.
For more information, contact:
Lynn K. Cadwalader
415.743.6981 | lynn.cadwalader@hklaw.com
Jim Norman
954.468.7888 | jim.norman@hklaw.com
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