Given the industry-wide effects from COVID-19, lenders are already aware that many clients in the hospitality industry will have difficulties staying current on their mortgages and loan obligations. This is especially true for hotels and restaurants. This blog series focuses on mortgage lending with regard to hotels and restaurants and the various options available to lenders.
This article provides an overview of the series and lender considerations when faced with hotel and restaurant borrowers who are unable to meet their mortgage and loan obligations. Parts 2 through 4 of this series will discuss pre-foreclosure options available to lenders. Parts 5 through 7 will discuss options available to lenders during the commercial foreclosure process. Finally, Part 8 will discuss considerations to be given for lending to hotels and restaurants in the post-COVID-19 era.
Prior to deciding what options are available, lenders should assess each hotel and restaurant borrower to determine the underlying business structure and to gather facts regarding the specific loan file. Understanding this structure is critical because hotel and restaurant ownership and operations involve complex management overlays that complicate working with many of these assets. Much of the underlying information may already be known based upon the analysis performed prior to extending the loan. Nevertheless, because financial conditions fluctuate and businesses change, it is important for lenders to ensure that all loan documents and loan files are complete and include the borrower’s updated financial information prior to developing a plan for handling the troubled loan.
Understanding the ownership and operation structure of hotels and restaurants
Hotel ownership and operations
There are multiple ways that hotels are owned and operated. For example, some hotels are independently owned and/or independently operated. Other hotels are owned and operated by a brand such as Marriott, Hilton, Hyatt, etc., or owned by a brand and managed by a management company through a separate management agreement. Alternatively, other hotels are franchised through a franchise agreement and may be separately managed by a management company through a management agreement with the franchisee. Identifying the underlying structure for the hotel is important because different considerations should be given depending on the type of hotel operation, including default/compliance with franchise agreements, management agreements, asset ownership, etc.
The majority of hotels in the United States are neither owned nor operated by a brand but are rather franchises, many of which are managed by management companies. It is therefore extremely important for lenders to understand and recognize how franchise and management agreements can potentially affect the value of the underlying collateral and the ultimate continued viability of the business.
Restaurant ownership and operations
Similar to hotels, understanding restaurant ownership and operations is vital for understanding the restaurant’s continued viability. If a restaurant is a franchise, the lender will have similar considerations to those considerations for hotel operations including separate franchise obligations and franchise fees. On the other hand, independently operated restaurants may not have the same obligations and fees that are associated with franchisees, but may involve complicated license agreements, additional investors or additional loans.
All of these considerations are important in performing a pre-foreclosure workup to assess whether the borrower is viable for a loan workout or whether there are more appropriate options such as pursuing personal guarantors or initiating foreclosure actions.
Given COVID-19 and the fact that lenders and borrowers are currently working together during this crisis, now is a great time for lenders to do some housekeeping so they are prepared to deal with borrowers after default, whether in a workout situation or litigation, with the goal of minimizing risk and maximizing recovery. At this point, lenders should review loan files for deficiencies or missing information. It is much easier to clean up the loan file during a period of cooperation than during a period of dispute.
For example, lenders should review their loan files to ensure the following:
- The lender has complete copies and required originals of all loan documents
- All documents were properly executed and notarized
- The lender’s understanding of the loan terms was properly documented
- The lender has an enforceable first lien on the commercial real estate and improvements
- The lender has a security interest in all personal property used in the operations
- The lender has an assignment of leases and/or rents
- The lender has a copy of all related franchise licenses and concession agreements
- All documents that were required to be filed or recorded were actually filed and/or recorded in the appropriate location or jurisdiction and properly stamped/marked copies are within the loan file
- If there is loan collateral involved, the lender should also confirm that all loan documents including any security agreements and UCC-1 financing statements accurately describe the collateral and that all liens were properly perfected and the lender has priority
If the lender is missing any of the above information, the lender should use this period of cooperation to obtain all documents to ensure that the lender’s loan file is complete and accurate.
Developing a Plan
After the lender is able to gather relevant information, the lender should begin to evaluate its options and develop a plan/strategy for handling the troubled loan. A lender has many available options, including:
- Selling the underlying loan
- Loan workouts/restructuring of the loan (as discussed in Part 2 of this series)
- Requesting a deed-in-lieu of foreclosure (as discussed in Part 2 of this series)
- Accelerating the loan and pursuing personal guarantors (as discussed in Part 3 of this series)
- Foreclosing on the mortgage (as discussed in Parts 5-7 of this series)
Numerous factors go into choosing which options a lender may decide to pursue. One of the most important factors is the value of the collateral. If the collateral is satisfactory, foreclosure may be an appealing option. If foreclosure is an appealable option, the lender may use the threat of foreclosure as leverage for aggressively negotiating a loan workout and potentially securing more favorable terms. The lender may also be able to sell the underlying loan or may accept a deed-in-lieu of foreclosure.
There are numerous considerations for lenders handling troubled hotel and restaurant loans. The best way to assess the lender’s options are for lenders to first gather the facts underlying the hotel/restaurant’s business and then give consideration to the available options. Because businesses are unique and involve different facts and considerations, each loan should be analyzed separately and on a case-by-case basis.
Part 2 of this series will explore pre-foreclosure options including loan workouts and deeds in lieu of foreclosure.
- Austin T. Hamilton, Esq.
- Pierce Schultz, JD Candidate