by David M. Neff, ISHC

The reports are about as dismal as anyone can recall seeing in the hotel industry in their lifetime.  Numerous hotel companies are experiencing drastic occupancy drops and implementing massive cost-cutting efforts, including laying off hotel workers ranging from housekeepers to franchise executives.  The outlook is very uncertain and dependent on many factors beyond the control of the hotel industry.
  
The worst thing that hotel owners can exhibit right now is paralysis or denial.  Immediate action is required on all fronts, including reducing costs, improving marketing efforts and  considering the legal options if business does not get better any time soon.
  
Although the hotel industry has greater operating efficiencies and less debt than during the last severe downturn in the late 1980's and early 1990's, it also had not suffered the impact of catastrophic events such as occurred on September 11.  Moreover, many hotels were already suffering from depressed financial performance when the terrorist attacks occurred.
  
Cash from operations will very soon get tight for many hotel owners, and they will have few other sources to access funds.  Not only are there few lenders willing to make loans to the industry right now, but also owners have less of their own capital to put into hotels because of the decline of their own stock portfolios.  Finally, many loans that were restructured last decade will come due in the near future, and few hotels have appreciated enough to allow their owners to refinance their debt.  So, what is a hotel owner to do?

Deal With Mortgage and Franchise Issues Now
  
At the outset, be honest with yourself.  Take a hard look at your hotel�s financial condition right now and where it is headed with regard to its two most important contractual relationships - its lender and its franchise company.  You have to consider crucial upcoming dates, such as when your hotel mortgage matures and when your franchise term expires.  The former is important because you cannot assume that your lender will be content to extend your loan.  The latter is important because you may be required to make substantial capital improvements to retain your franchise affiliation.  You cannot afford to wait until the last minute to deal with these issues.

Once you have identified your key dates, confirm that you have the best ownership structure for your hotel.  For almost anyone, the preferred method of ownership is by a legal form that prevents creditors from seeking repayment of their debts from your personal assets.  Such typical ownership is by a limited liability company (�LLC�), a limited partnership, or a corporation.  If you own your hotel as a sole proprietor or as a general partner, you are liable for all of the hotel�s debts.  Bad idea.

Protect Your Personal Assets

You also need to review your own personal financial situation.  Many states afford residents the opportunity to shield their houses from creditors� claims.  States like Florida and Texas offer almost unlimited exemptions for the equity in their residents� houses.  In Illinois, residents can own their houses by tenancy by the entireties, which means that a creditor must have a claim against both you and your spouse before it can try to satisfy its claim from the equity in your house.  Make sure you are availing yourself of these types of ownership structures with regard to home ownership and take advantage of other asset-protection devices, such as owning certain retirement accounts and annuities.

There is a word of caution.  If you are personally obligated on any debts, such as your home mortgage, hotel mortgage or franchise agreement, you may have signed a document agreeing that you would not materially change your personal balance sheet.  You also may be required to submit new personal financial statements on an annual basis.  If there are material adverse changes to your financial status, you may be in default under the applicable documents.  As a result, you must have these documents reviewed before you start transferring any assets.

Once you have assessed the key debts facing your hotel and your own personal financial situation, you need to plot a strategy.  No one strategy works for all situations, but there are a few rules of thumb.

Steps To Take

First, hire a good attorney.  As self-serving as that sounds, the simple truth is that a lawyer skilled in the specific discipline you need is likely to obtain a better result for you than one who is not.  If you need workout or bankruptcy advice, hire a reputable bankruptcy attorney.  If your problem is just with your franchise, hire a reputable franchise lawyer.
  
Second, try to work out your problems before taking more drastic steps.  If your major problem is with your hotel lender and you cannot find a new lender, you need to impress upon your lender that no one could do a better job operating the hotel than you.  In other words, you must convey to the lender that if it got the hotel back, the value of the hotel will decline, so why not be reasonable and try to work out a longer term solution with you.  But, be prepared.  Workouts do not come without their own costs and, depending on the lender, you may be required to release any claims you have against the lender, waive any claims you have against the hotel for loans you have made to it, escrow funds for capital improvements, taxes and insurance, or agree to place a deed to the hotel in escrow, which the lender can then obtain if you default under your loan.  Whether you are willing to agree to any of these terms will depend on the specific facts and circumstances of your situation.

If your major problem is with your franchisor, your approach will vary depending on the problem and your leverage.  If you need a reduction of your fees because of the hotel�s financial condition, you will need to be prepared to show the hotel�s predicament to the franchisor.  Your leverage usually is not great because the franchisor often can hold over your head not only a liquidated damages provision in its franchise agreement that penalizes the hotel if it leaves the system, but also your personal guaranty, which makes those liquidated damages your personal obligation.  That being said, all hope is not lost.  The franchisor may grant you some concessions.  At the very least, you should at least try to obtain some concessions before considering more drastic alternatives such as litigation or bankruptcy.

Finally, if all else fails, the choice of last resort is to file bankruptcy for the entity that owns the hotel.  You cannot even begin to consider this option if you are out of cash.  This is because any lawyer worth retaining will ask for a fairly sizable retainer because that retainer may be the only source of paying his fees in connection with the bankruptcy.  Therefore, if bankruptcy is an option, you have to start accumulating cash at the property.    

The bottom line is that hotel owners must take the necessary legal steps right now before it is too late.