May 6, 2009
By David Neff
You’d never buy a hotel without finding out about its operating history, the market and the seller’s motivation to sell. So why is it that when hotels face financial difficulties, their owners request modifications from their lenders without analyzing the factors that might influence the lenders to give them what they want?
Too often, hotel owners figure they have a good relationship with their lenders and all they have to do is explain the difficult times facing the hotel industry and their hotel and the lenders will grant modifications. Instead, owners need to do more due diligence before approaching the lenders to modify their loans. They need to understand how their lenders will view their modification requests and what will happen if they don’t agree.
The types of information a lender will consider—which means owners will need to consider these before approaching the lender—include:
1. What can your lender do for you. Who your lender is often makes all the difference in what it can do for you. If you have a securitized loan, your ability to negotiate any modifications to your loan before it goes into default is limited. However, once your loan goes to a special servicer after a default or imminent likelihood of a default, there’s a greater ability to modify loan terms. The key often will be whether you’re willing to put more money into your hotel or pay down the loan. For non-commercial-mortgage-backed securities lenders, their attitude might be more influenced by their financial condition and what your loan default does to their balance sheet. It’s crucial to find out as much as you can about your lender so you know what motivates it.
2. Personal guarantees. Hotel owners might have guaranteed their bank loan as well as their franchise agreement and equipment leases. Loss of the hotel might cause them to face substantial personal liability. For those who borrowed money from CMBS lenders, they likely have given springing guarantees that take effect when certain bad acts occur, such as causing the hotel to file for bankruptcy. If you have few personal assets with value available for creditors, these guarantees might be irrelevant. However, if the lender knows you have assets worth protecting, it’ll be more likely to insist you put additional funds into the hotel before agreeing to any loan modifications.
3. Stock pledges. Many mezzanine loans that were made required hotel owners to give pledges of their ownership interests in their hotel to the mezzanine lenders. That means upon default, the mezzanine lenders can seek to sell those ownership interests to the highest bidder (usually the mezzanine lender) after giving as little as 10 days notice of the sale. As a result, you might have little time to take action (such as filing for bankruptcy for the entity that holds the hotel ownership interests) should the hotel go into default on its mezzanine loan. Therefore, before you approach a mezzanine lender for any modifications when your hotel loan is in default or close to it, you have to be prepared to act quickly if you fail to reach an agreement.
4. Corporate authority. Corporate governance documents usually set forth what approvals you must obtain from the members, partners or board of directors of the entity that owns the hotel to modify a loan or file for bankruptcy. If you control all the directors, then this won’t be an issue because you can get the necessary consents quickly. However, if there are independent directors, obtaining the necessary approvals might be more uncertain and take longer. Approvals also can be more difficult to obtain when the managing members or general partners have springing guarantees because they might oppose a bankruptcy filing to avoid personal liability. If the lender knows bankruptcy isn’t an option because it will never be authorized, you can’t credibly threaten it.
5. Access to cash. If a hotel is cut off from its cash, it can’t operate—it can’t even file for bankruptcy absent a source to pay a retainer to a good bankruptcy lawyer. Lenders know this. As a result, it’s crucial owners assess their cash on hand and set aside funds in an account not controlled by their lender in case negotiations go poorly. Doing that can be difficult if cash gets swept regularly by the lender or the hotel bank accounts are with the same lender that holds the mortgage. The more the lender is in a position to control your cash, the less leverage you have in negotiations and the less likely you can get the concessions you seek.
6. Status of the franchise. Most lenders view a hotel’s franchise affiliation as extremely important and want to maintain it at all costs. Consequently, you need to review the lender’s rights, if any, should negotiations go sour and the lender seeks to obtain a receiver for your hotel. The first step is to review any comfort letter between the lender and franchisor. The fewer rights the lender has to keep the franchise affiliation, the more likely it might be willing to work with you on restructuring your loan.
The above is by no means an exhaustive list of the analyses you need to do before seeking a loan modification. It’s only meant to set forth a few important items you need to consider before you approach your lender. You might have only one opportunity to restructure your loan, so you need to get it right.
