The Importance of Comfort Letters in Financing Franchised Hotels
March 10, 2014 5:39am
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By Jim Butler and the Global Hospitality Group®
Hotel Lawyers | Authors of www.HotelLawBlog.com
10 March 2014
Comfort letters are more important than ever as franchising continues to be a dominant form of branding hotels. As many of our recent articles have noted, there has been a sea change in the hotel world. Franchise agreements have become the dominant means of branding most hotels in the US, except for a few of the most upscale and luxury brands.
This popularity of franchising has made comfort letters more important than ever simply by the predominance of the franchise model, and lender's desire to get certain protections that they feel comfort letters offer.
In today's article, my partner, hotel lawyer Robert Braun, explains what comfort letters are and the kind of provisions they usually contain.
Comfort Letters - Comfort for Whom?
Robert E. Braun | Hotel Lawyer
If you are buying, building or refinancing a hotel, you'll almost certainly be looking to a bank or other lender to finance the hotel, and when you do, you'll need to negotiate dozens of documents, some long, some short, but all of them necessary to get your loan. In other articles, we have talked about the importance of subordination, non-disturbance and attornment agreements (SNDAs). SNDAs are used in the context of a hotel management agreement (HMA) -- usually only long-term branded HMAs -- to define the rights of lenders vis a vis the hotel operator in the event of the owner's/borrower's loan default, breach of the HMA, foreclosure by the lender or a deed-in-lieu of foreclosure.
But what about franchised hotels? Lenders who take security in a franchised property will want a "comfort letter," an agreement between the lender and the franchisor that defines the rights of lenders and franchisors if the hotel owner defaults on its loan obligations, the franchise agreement or other related arrangements. In other words, lenders seek SNDAs to deal with their rights and obligations with respect to HMAs. They use comfort letters to deal with their rights with respect to franchise agreements.
What is a Comfort Letter?
A comfort letter is, essentially, a form of assignment of the franchise agreement for the hotel brand. It governs the ability of a lender to operate a hotel property under a brand name after a foreclosure, receivership or other loan default.
Why do Lenders Want a Comfort Letter?
Lenders make loans on branded hotels because they believe that a hotel is more valuable if it can be operated (and sold) as a branded property. If the hotel franchise agreement is terminated, the value of the property could drop significantly. Even where there is no foreclosure, the lender may want the ability to be able to "step into the shoes" of the borrower and continue to operate the property in the shoes of the borrower under the existing hotel Franchise Agreement. More than that, a lender will want to be able to sell the hotel after foreclosure (or in connection with a receivership or similar action), and may believe that transferring the franchise to a buyer will increase its recovery. This, of course, requires the consent of the franchisor/hotel chain.
Who Writes the Comfort Letter?
Most hotel brands have a standard form of hotel comfort letter and, as a practical matter, brands will insist on negotiating from this form. When parties ask a hotel brand to use a new or different form of comfort letter, the brand may refuse or, at best, it will delay loan closing until the negotiation over the form of comfort letter is concluded. While the lender's rights under the comfort letter are limited, most institutional lenders have been willing to accept the comfort letter as providing the lender with sufficient "comfort" that it will have the ability to maintain the franchise relationship and the value of its collateral in the specified events of the owner/borrower default.
What's in the Comfort Letter?
While each hotel chain's form of comfort letter differs to some extent, most comfort letters have the following provisions:
In addition, most lenders would like to be released from liability under the franchise agreement once it sells the hotel to a third party purchaser. Most hotel chains are willing to acknowledge that, in the event of a sale of the hotel to a third party that party can apply for a franchise agreement and that such application will be processed in accordance with the franchisor's then existing requirements and procedures.
What's the Challenge?
Comfort letters, while a key requirement for most lenders, are challenging to borrowers because- they require the lender and franchisor to come to agree on matters that have no immediate effect on them (or on the borrower!), but can prevent the closing of critical financing. Moreover, the lender and franchisor may have a different agenda than merely the facilitating the closing of the owner's/borrower's financing transaction. For example,- the lender may have other issues with the borrower, and the borrower may still be in the throes of finalizing the franchise agreement. Even in the best of situations, the borrower's counsel is often saddled with the task of negotiating a comfort letter that his or her client has little interest in, and trying to mesh the sometimes incongruent interests of the lender and the franchisor. The ultimate payoff to the borrower, of course, is the making of the loan by the lender.
Robert Braun is a senior member of the Global Hospitality Group® at JMBM. Mr. Braun advises hospitality clients with respect to hotel management agreements, franchise agreements and operating issues. He also advises on transactional matters, including entity formation, financing, and joint ventures, and works with companies on their data technology, privacy and security matters. These include software licensing, cloud computing, e-commerce, data processing and outsourcing agreements for the hospitality industry. He is a member of the International Association of Privacy Professionals. Contact him at 310.785.5331 or email@example.com.
For more information on hotel franchise agreements and hotel management agreements
The right hotel brand and management agreement can be the difference between success and failure of a hotel. The Global Hospitality Group® at Jeffer Mangels Butler & Mitchell LLP has negotiated, renegotiated, litigated and advised on more than 1,000 hotel management and hundreds of franchise agreements all over the world. To see how we help clients in this arena, please click here to see our brochure.
We also have a rich library of free resources available on most topics of interest to people dealing with hotels. These are all available at www.HotelLawyer.com. This is where you will find our free handbooks under the "Resource Center" tab.
For blog articles, scroll down any page of HotelLawyer.com and look on the right side for Topics that appear in red letters. For example, you can see all the blog articles on "Hotel Franchise & License Agreements" by clicking that link. The same goes for "Hotel Management Agreements" or any other subject you see listed down the right hand side of HotelLawyer.com.
The following are only a few of the relevant blog articles you will find there:
Hotel Franchise Lawyer: 8 things to negotiate in your next franchise agreement
When should you choose a brand for your hotel? And when should the brand manage your hotel?
Dual-branded hotels -- What every owner or developer should know
Hotel Franchise Lawyer: Hotel Franchise Agreements and the 5 biggest mistakes a hotel owner can make
Hotel Lawyer on Repositioning: The New York Times reports 39 percent increase in reflagging
The 5 questions every owner should ask before selecting a hotel brand
The HMA Handbook (2nd edition), Hotel Management Agreements for Owners, Developers, Investors & Lenders
Checklist for negotiating Hotel Management Agreements/Hotel Operating Agreements - The HMA PRO™ Checklist
Hotel Lawyer with insights on "How to get a great hotel operator"
How to get the right hotel operator
This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We've done more than $68 billion of hotel transactions and have developed innovative solutions to unlock value from hotels. Who's your hotel lawyer?
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: Jim Butler
+1 (310) 201-3526
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