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As Hotel Default Surge, Lenders Should Be Wary of Special Problems

As hotel values plummet, hoteliers are defaulting on their loans at what may become record levels. According to Real Capital Analytics, $18 billion in hotel loans are distressed. Plummeting revenue and soaring debt means things will only get worse before they get better.

In fact, a recent survey by Atlas Hospitality Group compares hotel sales activity and pricing in mid-2009 to the same period in 2007 and 2008. This comprehensive survey focuses on California, but the results reflect conditions throughout the country and relay some alarming statistics:

1. The median price per room is down 45% from 2007, and 37% from 2008.
2. The number of hotels sold is down 72% from 2007, and 51% from 2008.
3. The dollar volume of transactions is down a massive 88% from 2007, and 81% from 2008.
4. The number of hotels that sellers have put on the market is up 53% in just the first six months of 2009, with dollar volume up 78%.

The skyrocketing rate of defaults has spawned a burgeoning industry for hotel receivers, who are frequently appointed as an impartial third-party to preserve and protect the asset and its vital rights.

But those involved in the receivership and turnaround of troubled properties should be aware that there is a vast difference between traditional real estate entities like office buildings and "special assets," or operating businesses such as hotels, which are extremely management intensive and consequently carry a much higher risk than other commercial real estate.

For this reason, when drafting court orders it is critically important to view hotels first as businesses and only secondarily as real estate assets.

Unlike traditional or "passive" income properties -- such as office buildings, shopping centers and multi-family housing – hotels feature a retail component, which typically represents a significant portion of the value and involves a host of complex business issues. This requires specific knowledge of the business.

Having served as a receiver, trustee, custodian and/or manager for hundreds of hotels, at Trigild, our task is always greatly impacted by the court orders, which vests the receiver with its rights, duties and obligations. Court orders are critical to any takeover -- careful drafting not only saves time and helps curtail potential problems, but also can significantly affect the cost to the receivership or bankruptcy estate, and ultimately the amount recovered on the loan.

Problems and needs encountered when dealing with these properties range from taking stock of inventories to examining franchise agreements.

A Court Order Checklist for Hotels:

The following is a small sampling of the problems that can be encountered when working with hotel and resort properties and some specifics on how they can be dealt with in the “order appointing receiver.”

By covering all of these anticipated hurdles in advance, a return visit to court can be avoided, and assets can be protected more efficiently. Click here to read more.

1. Bank Accounts. A hotel may have multiple bank accounts – one for ordinary operating expenses, one for processing credit card transactions, another for reservation deposits, and yet another for capital reserves.
   
   There will also be many different cash banks for personnel such as desk clerks and bartenders or accounts used by the owner under a different name. With this in mind, the court order should specifically allow the receiver to seize all related accounts, and specify other entity names, if known. The receiver should be allowed to keep the accounts open in order to receive additional deposits or transfers, but be able to freeze all funds so no further checks can clear.
2. Inventories. A court order for a hotel should allow ample time for the filing of an inventory. An “inventory” may also include accounts receivable, which can be very substantial and complex. Most receivership statutes -- when they even exist -- refer to “receipts and disbursements,” not profits and losses, thus implying that accounting should be done on a cash basis rather than accrual basis. That being the case, it is usually advisable not to include accounts payable as inventories or assets, but instead to simply note the apparent amount and then reflect any payments as income when actually received. Dollar values should not be assigned to most inventories, since such valuations are highly subjective and can open the door to arguments later on.
3. Liquor Licenses. If a hotel has a restaurant, cocktail lounge or banquet services, it will have a liquor license, and the ability for the receiver to use this license is important to the continued operations of these amenities. With this in mind, the receiver needs complete authority to continue using existing licenses and/or to transfer or acquire licenses – so a court order which specifically addresses these licenses is key. A new license rarely allows for continued operation, and often takes months of processing, whereas, assignment, transfer or merely use of the existing license allows for continued operation.
4. Franchise agreements. A hotel is often branded through a franchise agreement. A specific franchise (or “flag”) can be a substantial benefit, but if poorly chosen, can be a huge detriment. Receivers experienced with hotels can not only quickly assess the flag’s value and successfully maintain the desirable identity, but can often improve on the terms of such agreements. The court order should allow the receiver to negotiate such agreements.
5. Books and Records. While rent roles and security deposit information are fairly uncomplicated in traditional real estate, much more detailed and critical business records are involved when dealing with special assets. For example, lengthy lists of major corporate accounts, travel agents, previous guests, daily reports and reservations are vital. The bottom line? Past business records are critical in retail assets.
6. Accounts Payable. Generally, a receiver has no obligation (or even right) to pay pre-receivership debts. The court may allow exceptions when the receiver feels it is necessary to protect or benefit the estate. When such expenditures can be anticipated -- i.e. for unpaid wages -- the initial order should allow either for the specific payment, or for discretion of the receiver.
7. Management Companies. Because of the cost savings and easy transition upon foreclosure, many lenders and servicers prefer to use a receiver who is connected to a management company. The court’s order should not only grant authority to hire a management company, but include a company in which the receiver is a principal, employee, etc. Naturally, the relationship should be disclosed to all parties at the onset of the receivership and management fees should be competitive.
8. Intercepting Mail. When dealing with retail businesses rather than traditional commercial income properties, it is typical for owner/operators to have many unique or personal methods of conducting their business. It is not uncommon for payments from major accounts, for example, to be directed to a location other than the subject property. For that reason, the receiver should have authority to intercept mail and to have the postmaster redirect business mail to the receiver’s offices.
9. Environmental Audits. It is frequently vital to the lender (plaintiff) to request an assessment of any environmental issues. Since it is also of importance to the receiver, along with health and safety issues, the order should specifically provide for access to conduct such inspections and audits.
10. Retaining Legal Counsel. Aside from routine evictions or collection matters, most judges do not like receivers to automatically retain legal counsel. If the need for separate legal counsel for the receiver is expected, the purpose should be carefully detailed to facilitate the court’s approval. An experienced receiver should not need to consult with legal counsel for most matters.
11. Personal property. With special assets such as restaurants, hotels, convenience stores and other businesses, very often the personal property may be leased. The receiver will need to determine who the actual owner is, and whether or not to continue honoring such leases. It may be beneficial to have the court order other parties not to remove leased equipment. However, in the case of a foreclosure action, third party lessors are not necessarily subject to that court’s jurisdiction. We have however seen language included in orders that states all persons who receiver notice of this order are enjoined in any way from disturbing the Receivership assets unless permission from the court has been sought and granted.
12. Restraining Orders. Orders appointing receivers commonly also include Temporary Restraining Orders, which prevent the debtor from canceling insurance policies, removing property, or interfering with the receiver’s responsibilities and duties.
13. Bonds. Every court seems to have its own method for determining what size bond the receiver should post. Some judges, in dealing with traditional commercial real estate, feel that one month’s rent receipt is an appropriate amount. This is based on the theory that once a month, when rents are collected, the receiver will have that much money on hand. The receiver on a hotel or restaurant, however, will rarely if ever have such an amount at one time, and a bond in that amount could be over a million dollars. Counsel should be prepared to suggest a reasonable amount to the court, with supporting reasons, since the cost of the bond is also an expense to the receivership estate.
14. Ex Parte or Noticed Motion? The typical hearing on a motion for appointment of a receiver is scheduled after appropriate notice to all parties, and may be set for a date days or weeks in the future. In some cases, counsel may seek an ex parte motion on an expedited basis. The motion can be held as quickly as the following day, with the notice to the other party sometimes being a simple phone call. Courts are naturally reluctant to grant a motion which removes an owner from his/her property on such short notice, so it is important to have a compelling reason.

Conclusion

Careful drafting is naturally important in all legal documents. However, the order appointing a receiver becomes even more important when an operating business comprises a substantial part of a real estate asset’s value. As more and more hotels default on their loans and go into receivership, a carefully crafted court order is critical.

Trigild News

Trigild's nationwide receivership and turnaround team is pleased to announce the following new assignments:

Adding more than $150 million in defaulted loans to its portfolio, Trigild was appointed Receiver for 13 apartment complexes -- encompassing nearly 5,000 units -- in Alabama, South Carolina and Texas. Trigild's team was onsite immediately, implementing detailed takeover procedures and correcting numerous deferred maintenance issues.

Utilizing its extensive expertise in retail and hospitality operations, Trigild was appointed Receiver for three hotels and three retail shopping centers: a 174-unit franchised hotel in Orlando, FL; a 370 unit suite-style hotel off the Vegas strip; a 61-unit motel in Indiana; 175,000 sq. ft. and 110,000 square foot centers in California and a 160,000 square foot center in Arizona. In addition to the receivership appointments, Trigild was hired as the management company for a 97 room hotel and spa in Desert Hotel Springs, CA and will oversee marketing and operations.

Working on a consulting basis, Trigild's team of hospitality experts performed two operational, marketing and financial reviews for resorts in California and upstate New York. In both cases, the lenders wanted a professional independent review to help make further decisions regarding potential courses of action with the assets.

Serving as an agent for the bank, Trigild is reviewing and evaluating the records and accounting practices for the nation's largest classic and collectible car auction. Our team of experts will be onsite near Fort Wayne, IN for the five day event.

The Trigild Lender Conference second early bird rate ends Sepember 21, 2009. Visit www.trigildlenderconference.com for registration or more information.