Loss of Brand – Affiliation Potential Liability for Unsuspecting Hotel Loan Guarantors By: Richard O. Kopf Everyone knows that there is no such thing as an absolute non-recourse loan anymore; virtually all lenders will require a carve-out or "bad boy" guaranty from the principals of the hotel owner. Initially, those guaranties were put in place to prevent fraud and misappropriation of rents and other income, and create full liability in the event of bankruptcy filings. Over the years, those guaranties have been greatly expanded to include, among a long list of other things, failure to pay taxes, assessments or insurance, to pick up collection costs and even recover for waste on the property. Traditionally, "waste" has been commonly viewed as physical damage to the property that could or should have been prevented by the owner/guarantor. However, in the hotel context, aggressive lenders have recently been expanding the term "waste" to include the loss of a hotel franchise. In a recent case in Dallas (U.S. Bank, National Association v. American Realty Trust, Inc.), the lender took the position that the change from a Holiday Inn to a Clarion brand resulted in loss in value of the hotel which constituted "waste," and the guarantor was liable for the amount of the damage. In that case, the court found in favor of the guarantor because the change in the flag occurred following the expiration of the Holiday Inn franchise agreement, not before, and was not the result of a default under the franchise agreement. The court indicated, however, that the decision could have been different if the loss of the franchise was due to a breach of the franchise agreement. Maybe more than any other factor, the franchise affiliation of a hotel has a material impact on the value of the hotel. Does the importance of the brand and the potential loan recourse associated with a deemed breach or termination afford the franchisor added leverage over the owner? In today's economy, when every hotel owner is working hard to keep costs in line and trimming budgets, a misalignment of interests can easily arise between the franchisor and owner (e.g., the franchisor requires upgrading to maintain "brand standards" when the hotel is losing money). When that misalignment of interests arises and the owner struggles to decide whether it can afford to comply with the demands of the franchisor, or whether it should delay the renovation until "next" year, the owner will have another matter to factor into their business model. Not only will they have to consider the risk that the disagreement could allow the franchisor to declare a default and terminate the franchise agreement, but also that the franchisor's actions could constitute "waste" to the hotel, and expose the guarantor to personal liability under the carve-out guaranty. While the loss of the franchise or failure to properly maintain the hotel or the failure to comply with a brand standard renovation is probably a breach of a covenant under the owner's loan documents, the more material issue likely arises under the guaranty. If "waste" could be expanded to include the loss of the franchise, what else could fall under that same umbrella? Are there other business decisions that reduce income or the value of the hotel that would allow an aggressive lender to make a claim against the guarantor? For example, what if the borrower decides to upgrade the hotel to a stronger brand but, due to market conditions, inadvertently positions the hotel in a weaker market position? How about a decision to hold the line on rate which results in lower occupancy? Or deciding to pass on a particular group event with the hope of picking up a better group that ultimately does not work out? Is any decision that results in lower REVPAR potentially one that constitutes "waste" since REVPAR is one of the key valuation metrics? Many of these decisions are the responsibility of the management company: is the guarantor at risk for decisions made by the manager? Can the guarantor avoid blame by hiding behind the decisions of the manager? Or does his failure to not be actively involved create MORE risk to the guarantor? The intent and language in the applicable guaranty and other loan documents will have a lot to say about which way the scale tips in these decisions. As a result, going forward I would expect significantly more attention to be paid to the mere inclusion of the word "waste" in a carve-out guaranty. |
