Hotels: Basics for the Real Estate Practitioner, Part 2

This is the second installment of a three-part series on real estate law regarding hotels. Part one can be found here.

This installment discusses issues that real estate practitioners should consider in the purchase or sale of a hotel asset. Such transactions present complexities related to the operation of the business in addition to the usual real estate–related issues, such as those associated with the title, taxes, and deeds.

Below are eight hotel-specific concerns you could encounter:

1. Should the Management and Branding Relationships Continue after the Sale?

The hotel management agreement (HMA) and franchise license agreements require careful review of sale considerations. Franchise agreements are usually personal to the asset owner and not transferable to a buyer. The buyer will need to obtain approval for a new license agreement with the franchisor. In contrast, hotel management agreements usually contemplate assignment to a new owner, although the manager’s consent could be required. An owner may negotiate the right to terminate the hotel management agreement upon sale—typically for a fee—to increase the marketability of the property. A sale is often an opportunity for a brand to perform a property improvement plan (PIP), which specifies the capital improvements to meet current brand standards, which may be costly. The buyer and seller should address whether the buyer will continue with the existing brand and management company for the property or adopt brand-new relationships early in the sale/acquisition process.

2. Are Vendor Agreements Transferable?

Unlike other real estate classes, hotels don’t have many tenants with leases but instead use vendor contracts for services such as laundry, IT, and valet, among many others, which are often signed at the property level without legal review. A buyer should understand which agreements are assignable and terminable upon sale. A seller will often give a blanket assignment for those that can be assignable. A contract audit should be done to determine which contracts should be, and can be, kept in place following the purchase. It can be a daunting and time-consuming part of diligence for a buyer because sellers tend to provide limited representations in the purchase and sale agreement about the contracts and expect buyers to rely on their own investigations. Furthermore, some contracts may be master or multi-property agreements that cannot be transferred, so the buyer will need to negotiate new contracts with these or new vendors.

3. What Is Included in the Purchase/Sale of the Property?

When buying assets such as an office building, understanding what you’re buying is typically straightforward, but a hotel is more complex. In addition to the land and improvements, the sale will also include assets such as information technology, intellectual property, accounts receivable, and the like, to the extent applicable. For example, if the intellectual property used in the hotel branding belongs to a third-party franchisor or management company that the buyer is not retaining after the purchase, the hotel will need to be debranded, and IP will need to be excluded from the sale. Alternatively, if the seller owns the IP itself, it may convey it to the buyer, unless it wishes to retain that for itself. Similarly, certain information technology systems could belong to third parties, which will also need to be excluded from the sale. This, like the contracts, requires a case-by-case analysis.

4. Will Sellers Provide Comprehensive Representations and Warranties?

Sellers’ representations and warranties are often subject to negotiation, as sellers tend to limit these, while buyers seek to expand them. These may cover physical and environmental conditions, financial performance, bookings, litigations, contract status, alterations, union and employee status, and the status of other encumbrances such as management and franchise relationships.

5. How Is Information about the Property Disclosed?

The purchase and sale agreement will generally contain numerous schedules of disclosures that tie to the seller’s representations in a manner more akin to a corporate transaction than a real estate transaction. These may include lists of material contracts, material litigation, violations of law, etc., depending on the extent of the representations that the seller is willing to make.

6. Does the Sale of a Hotel Require Government Disclosures?

Unlike the sale of most commercial real estate, in many states, the sale of operating businesses such as a hotel will require the parties to make bulk sales disclosures to governmental agencies, which could have a material effect on the timing of closing. Agencies will want to evaluate whether there are unpaid sales taxes related to the hotel, which could take some time. Without bulk sales sign-off or other permitted arrangements, such as withholding of closing proceeds, a buyer may become liable for the seller’s unpaid taxes.

7. Can a Seller Transfer a Liquor License to a Buyer?

Liquor license requirements vary by state, so local liquor license counsel is an important member of the team. Liquor licenses are generally personal to the seller and/or its management company and not transferrable. So, the buyer should devise a strategy to mitigate the downtime while a liquor license is pending, which could be lengthy. Some states permit the buyer to operate under the seller’s license on an interim basis under certain conditions. As with all other licenses and permits, the buyer needs to determine the most efficient way to secure those that are not transferable.

8. What Are Some of the Employee-Related Concerns?

There are myriad employee-related issues. The property may be subject to union agreements and employment contracts. Also, if the number of employees terminated upon sale exceeds certain statutory limits, a regulated “mass layoff” under federal and possibly local WARN (worker adjustment and retraining notification) acts could be triggered. The parties will need to understand what this means and know how to comply with notice requirements under the statutes to avoid potential liability. Buyers often interview the seller’s employees to consider them for ongoing employment, but the seller may want to retain some for other operations and not permit them to be interviewed. Granting the buyer access to certain employee records also could implicate employment laws.

Next month, the third installment of this series will present the final eight issues for real estate practitioners to consider in the purchase or sale of a hotel asset.