Hotel Loan Covenant Terminology

HOTELS ARE OPERATING BUSINESSES, but for lending purposes, hotels, have traditionally been financed s real estate. The following are some special aspects of hotel lending.  Many of these critical elements are appropriately addressed at the Term Sheet or Commitment stage, rather than leaving them to be negotiated in the loan documents:

 

FRANCHISE AGREEMENTS:  

A Hotel Franchise may be important to the lender's underwriting of a hotel's ecomonic performance.  Many contracts valuable to the real property collateral for a hotel loan, such as leases and management agreements, can be collaterally assigned to the lender and preserved after a mortage foreclosure.  However, major brand hotel franchise agreements typically are not assignable to hotel lenders and are not assumable by auction purchaser.  Also, the hotel lender is exposed to the risk of a borrower default under the franchise agreement and its termination before the hotel lender is in position to evaluate by oversight and compensate the defaulted royalty payment to the franchise.  In the absence of a separate agreement between the hotel lender and franchisor, the hotel lender faces the risk of franchise loss following a default and liquidation by lienholder or imposition of new franchise fees, property capital improvement requirements (known as property improvement plan or PIP.

COMFORT LETTER OR TRI-PARTY AGREEMENT:

To improve the lender's position it will require the franchisor to enter into a separate agreement addressing lender's lienholder security and franchisor termination rights upon a borrower franchise agreement default and lender rights to continue the franchise after lienholder taking control of hotel as a remedy to cure the default.  This agreement is know as a Comfort Letter or Tri Party Agreement.

TYPICAL COMFORT LETTER TERMS:

Franchisor default notificatioin to the lienholder lender, including time extension up to 120 days allowing the lender to gain access to the Management control of the hotel daily operations status. This is legally transferred by completing a liquidation procedure before the franchise rights are terminated with the removal of the franchise flag from the hotel property.

The lenders right to obtain a new franchise agreement and the lender's right to transfer the franchise agreement post-foreclosure to a purchaser of the hotel in operations, and relieved of all future franchise royalty liability under the franchise agreement.

The Hotel Lender lienholder will require a borrower covenant to perform it obligations under the franchise agreement and not amend or terminate the franchise agreement without the lender or lienholder's consent.  The borrower should negotiate for exceptions to the restrictions on the amendments for minor changes and modifications not detrimental to the lender or lienholder's interests, such as a franchise fee reduction or term extension.  Franchise & Tri-Party Agreement should detail the time the lender or lienholder has to respond on a timely basis hereafter to the "Approval Mechanism"

HOTEL MANAGEMENT AGREEMENT:  

The hotel lender or lienholder typically will require the assignement of any hotel management agreement to lender in the event of a severe defualt which would lead to a transfer of ownership by liquidation and sale of hotel property.  The hotel management agreement legal right to fee payments, will have to be subordinated to the hotel mortgage payments.  The borrower will be restricted from amending or terminating the hotel management agreement without lender's review and consent by written decree.  The borrower may desire to negotiate for the right to terminate a management agreement due to inappropriate General Management default or performance test, failure, or Management Agreement modifications which may conflict with the lender's collateral interest in the subject hotel property.

Lender or lienholder may required the borrower to replace the property management firm if there is a failure of financial covenants in the loan documents.  The borrower should determine at the loan commitment stage what rights the lender will require to force the hotel management company or general manager termination.  

SUBORDINATION, NONDISTURBANCE AND ATTORNMENT AGREEMENT (SNDA):

A hotel management agreement is a contract for services tha binds the hotel owner, but not the hotel real property, as distinguished from a lease of hotel space.  It creates a real property interest to which a future hotel owner's rights will ordinarily be subject.  A successsor hotel owner, including lender and lienholder acquiring by foreclosure, is not typically bound by the hotel management agreement and may terminate the existing hotel manager without liability to the legal agreement.  Major hotel management companies entering into long term hotel management agreements may require as a contingency, the hotel owner obtaining a hotel loan, the general legal principles, regarding hotel management agreement survival be reversed.  This change is accomplised through a separate agreement of the lender to be implemented by the hotel management agreement following a borrower default lender possession, commonly known as a Subordination, Nondisturbance and Attornmenta Agreement SNDA.  

PIP RESERVE:  

If the hotel financing is funding a branded franchise hotel acquisition, the franchisor may require a PIP to be completed following the closing property purchase and lender finance closing.  A hotel lender lienholder will typically require reconcilliation of the funds needed to cover the Franchise mandate PIP in a pledged reserve account registered to the loan proceeeds to be disbursed as the work progresses and upon project completion.  As an option to borrower, to negotiate a bank letter of credit for a reserve account.  In accordance with the franchsor's time schedule, the borrower should negotiate for the approval mechanism to apply to lender lienholder approval of plans, design changes, contractor and application for payments.