News for the Hospitality Executive |
The Hotel Purchase and Sale Agreement -- What is the Value of the Seller's Representations and Warranties to a Hotel Buyer? |
For the most
recent update on this topic, click here By Jim Butler, David Sudeck and the Global Hospitality Group® Hotel Lawyers | Authors of www.HotelLawBlog.com November 9, 2012 Hotels,
restaurants, resorts, vacation ownership
projects, spas, golf courses and other similar hospitality properties
are
different than most real estate. They involve operating businesses that
are
integrally intertwined with special purpose real estate. So the
documentation to buy or sell such a
property (and business) needs to be different than that used for other
commercial real estate. One of the areas that is most apparent is in
the
seller's representation and warranties. The article
below is by hotel and timeshare
lawyer David Sudeck, a senior member of JMBM's Global Hospitality
Group®, and
someone very experienced in the purchase and sale of hotels,
restaurants,
resorts, vacation ownership projects, spas, golf courses and other
similar
hospitality properties. In a recent article, David wrote about
representations
and warranties in a purchase and sale agreement -- what they are, what
areas
they cover, and what you want to get in a typical deal. In this
article, he writes about the value of
these representations and warranties, hurdles to enforcing them and
common
terms used today. This
article is one of a series of insights
that will be published initially as articles on the Hotel Law Blog at www.HotelLawyer.com
and then they will be
assembled into the HOW TO BUY A HOTEL handbook for our "We wrote the
book™" series, much like the HMA Handbook
and the Lenders
Handbook
for Troubled Hotels (see Resource Center
at HotelLawyer.com
for free copies). The
hotel purchase and sale agreement: Purchasing
real estate along with an operating
business (whether a hotel, restaurant, resort, vacation ownership
project, spa,
golf course or tennis facility) can be complex and risky. There are
practical
and financial limitations to the information that can be secured and
reviewed
during what is typically a short (e.g., 15-60 day) due diligence
period. In
most traditional sales (as opposed to note or foreclosure sales), the
seller of
the business and property will have knowledge of the assets, and
securing
representations and warranties from the seller regarding the subject
assets
will provide the buyer with some additional information, or comfort
that the
information the buyer already has is comprehensive and accurate. What is the value
of a seller's representations and warranties in a hotel purchase and
sale
agreement? Pre-closing
breach - The seller's representations and warranties can
have
significant value The purchase
and sale agreement typically
includes closing conditions in favor of the buyer which, if not
satisfied, will
provide the buyer with the opportunity to terminate the agreement and
receive a
refund of its earnest money deposit. These closing conditions almost
always
include a statement that the seller must have performed its covenants
under the
agreement and that the seller's representations and warranties must be
true and
correct (typically both when made and as of the closing date). So are the
seller's representations and
warranties important prior to the closing date? YES, as they may
support a
termination of the agreement by the buyer. In some circumstances, if
the
inaccurate representation or warranty also constitutes a breach of the
agreement by the seller, the buyer may also be able to seek damages for
the
breach by seller (which may be capped and limited to buyer's
out-of-pocket
costs incurred to date or may not be capped/limited, depending on what
the
buyer and seller negotiated in the default section of the agreement). The proper
drafting of both the seller's
representations and warranties and the buyer's conditions to closing is
critical. Depending on the knowledge qualifier used in the
representations and
warranties section and the wording of buyer's conditions to closing,
the
seller's representations and warranties may be true and correct even if
inaccurate. In such case, the buyer may not be able to terminate the
agreement
even if it discovers the inaccuracy prior to the closing date. At the
same
time, if the conditions to closing section is not drafted carefully, a
buyer
may be able to terminate the agreement and secure a full refund of its
deposit
(effectively securing a very extended "free look" period) if it
discovers even an immaterial service contract that was not scheduled in
accordance with the seller's representations and warranties. Needless to
say, these areas of the agreement
should be reviewed and drafted with great care, as they are
interrelated.
Sloppy drafting may result in unintended consequences, including the
ability of
the buyer to terminate the agreement without liability right up until
the
closing date. Post-closing
breach - The seller's representations and warranties may
have
relatively little value (depending on what the purchase agreement
provides) If the buyer
discovers post-closing that a
representations or warranty of the seller is false, then the buyer may
have an
opportunity to pursue a claim for damages incurred by the buyer (e.g.,
reduction of property value) or indemnification for amounts paid to
third
parties. However, the
protection is typically limited in a
number of ways. For example, it is not unusual for a purchase agreement
to
provide that any breach of a seller representation or warranty known by
a buyer
prior to closing is waived if the buyer elects to proceed to close
escrow
rather than terminate the purchase agreement. Such a provision is
generally
enforceable. As a practical
matter, I cannot remember even one
of my buyer clients pursuing a claim against a seller post-closing for
a breach
of representation and warranty. That might be a sign of the high
quality
sellers on the other side of my transactions, but it is more likely the
commercial reality of the marketplace. That is, purchase agreements
often
include limited seller representations and warranties, and little
recourse if a
breach is discovered, particularly in overcoming the hurdles of
enforcement. What are the
hurdles to recovering? Proving knowledge:
If the seller's representations are qualified by
knowledge, then
in order to successfully recover from the seller in an action against
the
seller based on a claim of breach, the buyer will need to prove that
the seller
had knowledge (or in some limited cases, where the knowledge qualifier
is not
limited to "actual knowledge," then the buyer must prove the seller
should have had knowledge) of the inaccuracy of the statement in
question. This
can be an extremely difficult hurdle to overcome unless the buyer has
found the
"smoking gun" memo evidencing such knowledge. Limited
survival period: The seller typically will seek to
limit the
survival of any of its representations and warranties to a fairly short
period
of time (e.g., 3 to 12 months), and this will provide the buyer with a
limited
period of time to both discover an inaccuracy and make a claim. Bucket and Cap:
The seller will often negotiate for a "bucket" (i.e., a dollar amount
below which seller will have no liability for a breach of its
representations
and warranties). This may be documented as a threshold above which
seller will
have liability for the entire claim or a deductible above which seller
will
begin to have liability . (Obviously, the former is preferable if you
are the
buyer!) and a "cap" (i.e., a maximum liability for such breach). This
will sometimes mean that the buyer will have no recourse for "small"
claims (even if the seller breached its representations and warranties)
and
will have limited recourse for larger claims. This sort of arrangement
may
remove much of the incentive of the seller to carefully review its
files and
its statements, and therefore, the buyer should carefully consider the
implications of agreeing to this provision. Limitation on
Remedies: The purchase agreement may provide that the
sole
remedy of the buyer in connection with a post-closing claim of breach
and
representation or warranty will be a claim for indemnification. This
may
effectively prevent the buyer from seeking to rescind the contract
based on the
inaccurate statements of seller, which may otherwise be available to
the buyer
under contract law; however, there are numerous cases (including the
2006 ABRY
Partners case out of Delaware) that provide that buyers have remedies
under
tort law (e.g., based on claims of fraud or negligent
misrepresentation) even
where the contract purports to significantly limit available remedies. Holdback or
Joinder: The seller will likely be a single purpose
entity. So
what if the seller does breach its representations and warranties and
what if
such breach is discovered during the survival period and it is of a
sufficient
amount to support a claim for damages or indemnification? If the
seller, after
the close of escrow, distributes its sales proceeds to its
members/partners,
then the buyer will be in the unenviable position of having to trace
the
proceeds by making claims of fraud or inadequate capitalization of the
selling
entity to cover expected contingent liabilities. Therefore, as
a buyer, it is important to make
sure that the seller has a pool of funds to cover the damages
associated with a
breach (as well as the seller's post-closing indemnification and
proration
obligations). This issue can be addressed in a number of ways, but the
easiest
and most typical way to address the issue is to require either of the
following: (a)
Holdback. The
seller to holdback with a escrow
agent (and therefore not distribute to its members/partners) a mutually
agreed
upon amount expected to cover contingent liabilities for the period
during
which such claims may be brought by buyer, or (b)
Guaranty or joinder. The
parent company or principals of
the seller (i.e., an entity or person with substantial assets or
liquidity) to
sign a guaranty or joinder to be jointly and severally and primarily
liable for
the post-closing liabilities and obligations of the seller. The take-away? If drafted with care, the purchase agreement can be negotiated and drafted to avoid an unintended extended "free look" period for the buyer and yet provide a meaningful incentive for the seller to make accurate statements with respect to the subject property that help the buyer complete its due diligence as quickly and as comprehensively as possible. David's practice primarily involves the complex issues associated with hotels, resorts, vacation ownership properties (including clubs, timeshares, fractionals and private residence clubs), restaurants, golf courses and spas. He represents several financial institutions and private equity funds as special counsel relating to their hospitality interests. David has a pragmatic approach to practicing law, and he adds value through his business experience and legal expertise, his finance, entitlement and development knowledge, and his extensive relationships with investors, lenders, brokers, developers, and service providers. Contact David Sudeck at 310.201.3518 or [email protected]. HOW TO BUY A
HOTEL -- Free handbook Until the free handbook on HOW
TO BUY A HOTEL is
published (expected in Summer 2014), you can access all the materials
on this
subject at www.HotelLawyer.com.
Look
on the right hand side of the home page and click on "Buying
&
Selling a Hotel."
Here are a few of the articles on the subject under this topic:
This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We've done more than $60 billion of hotel transactions and have developed innovative solutions to unlock value from hotels. Who's your hotel lawyer? __________________________ Our Perspective. We represent hotel lenders, owners and investors. We have helped our clients find business and legal solutions for more than $60 billion of hotel transactions, involving more than 1,300 properties all over the world. For more information, please contact Jim Butler at [email protected] or +1 (310) 201-3526. Jim Butler is a founding partner of JMBM, and Chairman of its Global Hospitality Group® and Chinese Investment Group™. Jim is one of the top hospitality attorneys in the world. GOOGLE "hotel lawyer" and you will see why. Jim and his team are more than "just" great hotel lawyers. They are also hospitality consultants and business advisors. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them. |
Contact: [email protected] 310.201.3526 |
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