Hotel Management Agreements

Hotel Management Agreement Negotiations - The Owner's Lender - Why Does the Operator Impose Restrictions and Requirements?

Owners negotiating their first HMA struggle to understand why operators can adopt such an intrusive attitude to the owner's financing. This is particularly the case if the negotiations with the operator precede negotiations with the owner's prospective financier. In many instances the HMA negotiations precede the point in time where the owner knows the identity of its financier let alone the terms upon which the financier is prepared to lend.

For these reasons it is incumbent upon an owner's advisers to ensure that the financing restrictions that the owner agrees to are as flexible as possible. Equally, it is incumbent upon the negotiators acting for the operator to maintain flexibility particularly in a "beauty parade" scenario where undue rigidity may impact adversely upon the operator's commercial proposal or, even more starkly, disqualify the operator from the process.

Since we are based in Australia, we will approach the questions below from a broadly Australian perspective. However, the  good news is that we have 17 offices in Asia Pacific and many more around the world to answer any of your jurisdictional specific questions.

  
Topic     Discussion
  1. Why is the operator interested in the owner's financing arrangements?
The operator has only a contractual relationship with the owner. This means that in the absence of a contractual arrangement with the financier, should such financier move into possession of the hotel (or appoint a receiver) the financier can effectively ignore the HMA and deal with the hotel - both in an operating and sale perspective - as if the hotel management agreement did not exist. The operator's remedy would be to seek relief as one of the owner's unsecured creditors.

The plight of the operator is even more stark when it has provided any form of financial contribution to the owner whether potentially refundable or not. 

 

  1. What is the purpose of a non-disturbance agreement ("NDA")?
An NDA is a tripartite contract between the operator, the owner and the owner's lender.

Operators like an NDA because it establishes a contractual relationship with the lender such that if the lender goes into possession of the hotel it is required to abide by the terms of the hotel management agreement (which would not be the case in the absence of the NDA).

Lenders like to have an NDA because it usually provides that the operator cannot terminate the HMA as a consequence of the lender going into possession which would leave the lender potentially without an operator to manage its hotel.

An owner is effectively the "meat in the sandwich" as it needs to seek to cajole the operator and the lender to agree on the form of the NDA. 

 

  1. What issues can arise from an NDA?
Whilst both lenders and operators usually require an NDA, each can have different views as to what the NDA should say. For example some lenders effectively want the right to either sell the hotel subject to the HMA or with vacant possession (when this flexibility is not contained in the HMA). This is a major issue for most operators as their primary reason for requiring an NDA is to ensure that the HMA is honoured by the lender.

We are aware of one instance where a lender would only agree to enter into an NDA on the basis that there was an increase in the interest rate that would otherwise be payable by the owner for the financing.

 

  1. What practical approaches can be taken to NDA issues?
A number of operators will agree to a provision to the effect that if the Loan to Valuation ratio is above a specified percentage then there is an absolute obligation on the owner to secure an NDA.

Below this specified percentage the owner has the less stringent obligation to use its reasonable efforts to secure an NDA. Some operators seek to specify what action it expects the owner to take to satisfy the reasonable efforts obligation.  

 

  1. What other restrictions can operators impose in relation to the owner's financing arrangements?
These include:-
  • Finance document disclosure;
  • Borrowing limit requirement based on a specified % of Hotel valuation/construction cost;
  • An interest cover ceiling based upon projected Hotel cash flows;
  • Agreement that the Hotel cannot be cross-collateralised.
  1. What complications arise from mixed use developments?
If an owner is developing a mixed use development (hotel, commercial, retail etc) then usually by necessity it must borrow from a single lender and use the site and the development under construction as security. Operators dislike this but practically speaking there is very little that the owner can do until the development is constructed and a separate financing can be obtained in relation to each component such as the hotel. The means of dealing with operator concerns relating to mixed use developments are complex and can be very time consuming to work through.

 

  1. Is there a role for side letters ?
Side letters are used to provide specific concessions from the stringency of the HMA but generally only apply to the initial owner.

The operator may relax any one or more of the  requirements referred to in paragraph 5 above and document this in a side letter as opposed to the HMA. This is particularly important for the initial owner if it is negotiating the HMA in advance of identifying its lender and accordingly advised as to what the lender would be prepared to agree to with respect to the matters referred to in paragraph 5.

 

  1. Other considerations
HMAs are typically long term contractual arrangements (usually over 10 years). Traditional sources of finance which exist today may change tomorrow and therefore financing requirements and restrictions ideally should be sufficiently flexible to take such potential changes into consideration.

About Baker & McKenzie

Founded in 1949, Baker & McKenzie advises many of the world’s most dynamic and successful business organizations through more than 11,000 people in 77 offices in 47 countries. The Firm is known for its global perspective, deep understanding of the local language and culture of business, uncompromising commitment to excellence, and world-class fluency in its client service. Global revenues for the fiscal year ended 30 June 2014, were US$2.54 billion. Eduardo Leite is Chairman of the Executive Committee. (www.bakermckenzie.com)



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