ISSUES IN THE ORIGINATION AND WORKOUT OF HOTEL LOANS

Nancy R. Little McGuireWoods LLP

Copyright © 2011 Nancy R. Little

TABLE OF CONTENTS

I. GENERAL ................................................................ 1

II. ANATOMY OF A HOTEL LOAN .......................... 1

A. General Considerations ................................. 2

B. Collateral for Hotel Loans ............................. 3

C. Hotel Provisions in Loan Documents ........... .4

D. Comfort Letter for Franchise License Agreement ....... : ...................... , ...................... 7

E. SNDA with Hotel Manager. .......................... 7

III. MAINTAINING THE BRAND: HOTEL COMFORT LETTERS .............................................. 9

A. General .......................................................... 9

B. Notice of Default and Right to Cure ........... 10

C. Additional Time for Foreclosure ................. 10

D. Post-Foreclosure: New Franchise Agreement ................................................... 11

E. Additional Provisions for Comfort Letters .......................................................... 12

IV. RE-BRANDING THE HOTEL.. ............................. 13

V. RENEGOTIATING THE MANAGEMENT AGREEMENT ........................................................ 13

VI. CHANGE OF HOTEL OWNERSHIP .................... 15

A. Change in Management: WARN Act... ....... 15

B. Liquor and Other Licensing ........................ 15

C. Sales and Use Tax; Successor Liability ...... 17

D. Other Agreements and Licenses .................. 17

E. Other Diligence ........................................... 18

VII. BANKRUPTCY CONSIDERATIONS; RECEIVERSHIPS ................................................... 18

A. Hotel Management Agreements: Rejection in Bankruptcy .............................. 18

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TABLE OF CONTENTS (continued)

B. Characterization of Hotel Revenues in

Page

Bankruptcy .................................................. 19

C. Receiverships ............................................... 20

VIII. CONCLUSION ....................................................... 21

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Biographical Information

Nancy R. Little is a partner in the law firm of McGuireWoods LLP. Her practice includes the areas of finance and real estate law, with experience in lease financings, real estate lending, public/private partnerships, tax -exempt and taxable financings, corporate real estate development and financing and hospitality and health care facilities.

Ms. Little received her B.S.· from Virginia Polytechnic Institute and State University and her J.D. from the University of Virginia School of Law. She is a member of the Virginia State Bar, the Virginia Bar Association, the National Association of Bond Lawyers, .the National Health Lawyers Association, the International Association of Attorneys and Executives in Corporate Real Estate, the American College of Real Estate Lawyers, the American College of Mortgage Attorneys and has served as Group Chair of the American Bar Association's Real Estate Financing Committees in the Section of Real Property, Probate and Trust Law.

Ms. Little may be contacted at McGuireWoods LLP, One James Center, Richmond, Virginia 23219; 804.775.1010 (direct dial telephone); 804-698-2101 (direct facsimile); nlittle@mcguirewoods.com (e-mail).

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ISSUES IN THE ORIGINATION AND WORKOUT OF HOTEL LOANS

Nancy R. Little McGuire Woods LLP

Copyright © 2011 Nancy R. Little

I. General.

Hotel properties have experienced a drop in hotel room occupancy and rates, as well as a decline in revenue per available room or "RevPar". Over the last several years, lenders have dealt with distressed and defaulted hotel loans. The following outlines some of the issues facing the lender in preparing for a troubled hotel loan, from initial loan documentation considerations to issues in pursuing a foreclosure after the hotel loan is in default.

II. Anatomy of a Hotel Loan.

From the lender's perspective, preparation for a distressed hotel loan begins at origination and initial loan closing, with well-drafted and complete loan documents and careful handling of the loan closing. In secured hotel lending transactions, the parties enter into relatively typical loan agreements and mortgages; however, these documents contain certain provisions specific for hotels, and there are additional documents and considerations for hotel loans that are described below. The following are documentation issues that the lender should consider up-front before the loan is closed and includes a list of provisions and documents that the lender and its counsel should look for and review at the first sign of distress in the hotel loan.

A. General Considerations.

Although hotel loans are secured by real estate assets, typically, the real value of the collateral is in the "brand" for a branded hotel and in the revenues flowing from the operation and management under the hotel management agreement. Accordingly, hotel loans more closely resemble loans made to operating businesses than secured real estate loans. The situation is complicated further by the control and rights held by third parties: the franchisorllicensor and, if not "brand managed," the manager/operator.

Hotels that are a part of a branded chain operate under a franchise license agreement that includes the use of the brand name, chain services and an array of other rights, including the brand's reservation system. In the case of "brand management," the hotel is operated by the franchisor or its affiliates under franchise and management agreements. The franchise rights and management services may be combined in one document or may be separate agreements. If the hotel is managed other than by the franchisor, there will be a third party manager that has additional rights. The ownerlborrower will hold the franchise license agreement with the franchisor and will enter into a management agreement with the third party manager for management of the hotel in accordance with the requirements of the brand.

In addition, there may be other services of importance to the hotel that affect the lender's collateral. For example, the hotel may have been built on land subject to a ground lease, in which case the mortgage will need to include typical leasehold mortgage provisions. There also may be a restaurant on the property operated under a separate lease. If the hotel serves alcoholic beverages, the manager, the owner and/or other parties may hold a liquor license. It should be noted that "limited service" hotels, as well as full service properties, may require liquor licenses if the hotel includes a bar or if free drinks are served during a "manager's happy

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hour." The lender will want a lien on all the owner's rights and revenues under the leases and licenses, though certain rights, such as the right to serve alcoholic beverages or to operate an outdoor cafe on a city sidewalk, usually are not assignable, and the lender or other purchaser at foreclosure must apply for a new license or licenses. In certain jurisdictions, it may be possible to provide these services under temporary agreements or arrangements pending foreclosure and issuance of a new license or licenses.

The hotel furniture, fixtures and equipment ("FF&E") are critical to the hotel's operation. Accordingly, FF&E reserves generally are required by the manager and the lender to replace the FF&E as and when needed. Reserves for other capital expenditures upgrading the hotel to comply with brand standards under a product improvement plan ("PIP") and sometimes for repairs required at the time the hotel loan is closed. The lender will want a lien on and security interest in all such reserves, which may be complicated by the manager's rights to use the reserves under the management agreement, usually including access to the accounts in which the reserves are held. Sometimes, brand managers may require that the manager, not the lender, hold the reserves. In addition, the manager will have access to the hotel's operating accounts. All such considerations can impact the lender's effective exercise of its rights and remedies under the loan documents.

B. Collateral for Hotel Loans.

As noted above, the collateral hotel loans consist of a mix of physical assets, intangibles and revenues and receipts from the operation of the hotel. The collateral that the lender typically will want to encumber with a lien and security interest includes the following:

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1. All hotel physical assets, including all furniture, fixtures, equipment and food and beverage inventory, as well as any retail inventory.

2. All of the owner's rights under all franchise license agreement, management agreements and other operating agreements relating to the hotel operations.

3. All revenues and receipts from hotel operations, including room charges, revenues from the sale of food and beverages, laundry, health club, business and/or catering services, advance deposits and all other hotel revenue, and including distributions to the owneriborrower under the management agreement.

4. All reserves, deposits and escrows held for repair or replacement of the physical assets or other capital improvements as well as any tax and/or insurance escrows.

5. All accounts established for reserves, escrows or hotel revenues.

6. All documents, instruments, chattel paper and general intangibles and all property agreements, such as condominium or conversion plans.

C. Hotel Provisions in Loan Documents.

The lender will want to include rights and remedies specific to hotels in addition to the usual protections included in the lender's secured loan documents. Provisions that may help a lender facing a distressed hotel loan include the following:

1. The borrower is required to obtain the lender's consent for:

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a. Exercise of options and/or approvals provided for under the license and management agreements.

b. Replacement, assignment and/or renewal of the franchise license and/or management agreements.

2. The borrower is required to provide to the lender copies of all budgets, financial reports, inspection reports, forecasts, operating plans and notices of default, termination and/or other notices.

3. The license and management agreements (or a separate subordination agreement or comfort letter with the lender) are required to provide that:

a. Such agreements are subject and subordinate to the mortgage and the lender's rights thereunder.

b. Upon foreclosure or deed in lien thereof, the lender will have a period of time (for example, six months) to elect to confirm or to terminate the license and/or management agreements.

c. Until termination, the manager and franchisor, as applicable, will continue to operate under the license agreement or management agreement, as applicable.

d. Fees (including incentive fees and other performance-based fees) payable to the franchisor or manager under the applicable agreement will be non­cumulative and payment of such fees is subject and subordinate to payment of all amounts payable under the lender's loan.

e. The lender's consent is required for all amendments, modifications and/or extensions.

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f. The lender will receive all notices of default or termination.

g. The manager or franchisor, as applicable, will accept cure of default by the lender and will give the lender additional time (for example, an additional thirty days) to effect such cure and/or to foreclose; if the default is not capable of cure by the lender, then the foreclosure will be deemed to cure such default.

h. Neither the lender nor its transferee after foreclosure will be liable (i) for defaults of any prior owner, including the borrower, (ii) for any loans to a prior owner from the manager or franchisor or (iii) after sale or other transfer of the hotel by the lender or such transferee.

i. If the manager receives notice of a loan default from the lender, the manager will forward to the lender all amounts otherwise payable to the ownerlborrower.

4. The borrower will indemnify the lender and hold the lender harmless from and against claims and liabilities under the franchise license agreement and management agreements.

5. The ownerlborrower will provide to the lender copies of the manager's budgets, as well as income, cash flow and other financial statements, prepared in accordance with the Uniform System of Accounts for Hotels published by the Hotel Association of New York. The lender also has the right to receive and approve the manager's annual operating plan with respect to matters such as hotel operations, capital improvements and marketing for the hotel.

6. The lender has the right to hold, and to approve the use of, all reserves. The manager is not permitted to intermingle the reserves for the hotel with other reserves for hotels the manager manages.

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7; The mortgage should specifically include a cross default for defaults that occur under the franchise license agreement and/or the management agreement, and the lender may want notice and cure rights for such defaults.

D. Comfort Letter for Franchise License Agreement.

As noted above, much of the value of the hotel is in the franchise license agreement, which permits the hotel to be operated under a certain brand, make use of the franchisor's reservations system, etc. Re-branding of a hotel is costly and time-consuming. Accordingly, the lender will want the franchisor to agree that, after a default by the borrower and foreclosure of the loan, the lender or other purchaser in foreclosure can continue to operate the hotel as part of the same chain or brand of hotels and under the same or a comparable franchise license agreement. It is typical for the lender and the franchisor to enter into a "comfort letter" to address the agreements between the parties in this situation. Comfort letters are discussed in more detail in Section III, below.

E. SNDA with Hotel Manager.

The hotel management agreement providing for the operation and management of the hotel produces the revenue stream to pay the lender's debt service. If the hotel is in distress, the cause may be tied to the manager's operation of the property or it may be related to the overall economy, the hotel market or other factors. Consequently, the lender may or may not want to retain the existing hotel management following a default and foreclosure on the hotel. It may be the case that the lender will want to retain the existing franchise license agreement but wants to terminate the existing management agreement and replace the third party manager that may be underperforming. Therefore, it is important for the lender to have in place a subordination,

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non-disturbance and attornment agreement ("SNDA") with the manager that permits the lender to terminate the management agreement if the manager is in default under the management agreement but would require the manager to continue to perform and recognize the lender or other purchaser in foreclosure as the owner if the manager is not in default andlor the lender elects not to terminate the management agreement.

Typical provisions that the lender will want to have included in the SNDA include thefollowing:

1. The manager is required to give the lender notices of default by the borrower under the management agreement.

2. The lender has an opportunity to cure the borrower's defaults, preferably with a longer period of time to cure than is afforded to the borrower under the management agreement, and the manager is required to accept such cure.

3. The manager will not terminate the management agreement for a default by the borrower if the lender is preparing to foreclose.

4. The manager agrees to enter into a new management agreement with the lender, its affiliate or other purchaser in foreclosure or will permit an assumption by such party of the existing management agreement.

5. The parties will cooperate to avoid notification under or violation of the Worker Adjustment and

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Retraining Notification Act of 1988, 29 U.S.C. §§ 2101 et seg. ( the "WARN Act"). 1

Temporary disruption of hotel operations due to changes in management can impair the hotel's revenues and receipts, future bookings, etc. Therefore, tbe lender will want to carefully negotiate the SNDA and will want to proceed cautiously to enforce its rights as discussed below.

III. Maintaining the Brand: Hotel Comfort Letters.

A. General.

Comfort letters between lenders and franchisors vary in form and substance and are often updated or modified by the franchisors so that the form used at the time the loan is originated may not be the same form used, for example, when the loan is assumed. The usual parties to the comfort letter are the hotel franchisor and lender, though the borrower/franchisee may join in the letter agreement to acknowledge and agree to its terms and to make representations and warranties as to certain factual matters. From the lender's perspective, the comfort letter also should state tbat it is expressly for the benefit of any affiliates of the lender, including subsidiaries or affiliates that may acquire title by foreclosure or deed in lieu of foreclosure. In addition, the lender will want the term "lender" as used in the comfort letter also to include any successor noteholders, including trustees and sometimes servicers in securitization transactions in case the loan is securitized. The franchisor may stipulate that it will only recognize subsequent lenders as to which it has been given notice to be sure it is dealing with the current noteholder. In such cases, the lender should

1 The WARN Act requires either prior notice to employees of massive lay-offs or that a certain number of employees continue to be employed at the hotel.

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take care to insure that the franchisor is given notice of assignment of the loan.

B. Notice of Default and Right to Cure.

It is critical that the lender receive notice from the franchisor of any default by the borrower under the franchise license agreement. The lender also needs the right (but does not want to be obligated) to cure any such default of the borrower. The lender wants the cure period to be as long as possible so that the lender can attempt to cure the default and prevent termination of the franchise license agreement as a result of such default. However, at some point, the franchisor will want to be able to terminate the franchise agreement if the default is not cured. Typically, the comfort letter will provide for at least some notice to, and an opportunity for cure by, the lender, with the cure period usually extending for a period of time beyond the cure period provided to the borrower under the franchise license agreement. The lender also will insist on receiving notice of default under the franchise license agreement at the same time such notice is sent to the borrower. The franchisor may limit the lender's right to cure to only those defaults that are capable of being cured by the lender; however, the lender will not want the franchise license agreement to terminate if the lender cures all other defaults and may request that the franchise agreement cannot be terminated if the borrower's default is not susceptible of cure by the lender.

C. Additional Time for Foreclosure.

The lender will require a period of time beyond the cure period provided to the borrower under the franchise license agreement for the lender to cure certain non-monetary defaults, such as the failure of the borrower to maintain the hotel in accordance with brand standards. The cure of these and certain other defaults may require that the lender acquire possession of the hotel through foreclosure (or deed-in-lieu

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of foreclosure), which can take substantial time in certain jurisdictions. Therefore, the lender will want the franchisor to forebear from terminating the franchise license agreement as a result of this type of default by the borrower until the lender has acquired title to and/or possession of the hotel.

The franchisor may be willing to do so under certain circumstances. For example, the franchisor may require that the lender not delay in taking remedial action and begin foreclosure during the original cure period provided to the borrower under the franchise license agreement. In addition, after the lender acquires possession of the hotel, the franchisor will expect the lender to cure promptly and diligently all such defaults and may require that the cure be within the time period provided to the borrower under the franchise license agreement. The comfort letter usually provides for an exception, however, for defaults that are personal to the borrower, that cannot be cured by the lender, such as insolvency of the borrower or failure to maintain corporate or other status, and that do not affect the operation of the hotel and are not related to health or safety. The lender should not be required to cure these types of defaults. However, the franchisor may try to retain the right to terminate the franchise license agreement if the default could involve any damage to the reputation of the franchisor.

D. Post-Foreclosure: New Franchise Agreement.

After the lender (or an affiliate) acquires title to the hotel in foreclosure, the lender and the franchisor will need to enter into a new franchise agreement, or the lender will need to assume the existing franchise license agreement, in order to continue the operation of the hotel under the existing brand. Provisions for entering into a new franchise license agreement or assuming the existing agreement should be included in the comfort letter. The franchisor often wants a new franchise license agreement instead of the assumption of

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the existing agreement. The form of franchise license agreement may have been updated by the franchisor or there may be provisions specific to the borrower. Therefore, the lender should be prepared to enter into a new franchise license agreement.

In addition, the lender will not want the franchisor to require hotel upgrades or improvements that often accompany voluntary (non-foreclosure) transfers by the borrower. The lender will need comfort from the franchisor that, after foreclosure and taking of possession of the hotel by lender, the lender will not unreasonably withhold consent to qualified third party management proposed by the lender for the hotel. The lender also needs the ability to dispose of the hotel at some point after foreclosure and will want the franchisor to be reasonable in negotiating a new franchise license agreement with the buyer. The lender will want a release from liability under the franchise license agreement after a third party buyer enters into a new franchise license agreement with franchisor.

E. Additional Provisions for Comfort Letters.

Although the lender may have requested (or have the right to request) that the franchise license agreement be subordinate to the loan and lender's rights under the loan documents (such as the right to direct the use of casualty and condemnation proceeds), complete subordination of the license agreement could result in the termination of the agreement at foreclosure. Therefore, it is important that the parties agree that the franchise license agreement can be assumed by the lender (or its affiliate) or a third party buyer at foreclosure (or its or their transferee) or that the franchisor will enter into a new franchise license agreement after foreclosure. The comfort letter may also require cooperation by all parties in connection with foreclosure to avoid triggering or violation of the WARN Act.

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IV. Re-Branding the Hotel.

After foreclosure, the lender may want to terminate the franchise license agreement and "re-brand" the hotel. Depending on the circumstances, the existing franchisor may permit such termination if exercised within a short window of time after foreclosure and, possibly, with some relief from the usual termination fees payable under the franchise license agreement for termination.

If the hotel is to be re-branded, the new franchisor will likely require significant "product improvement plan" ("PIP") improvements and expenditures for the hotel in order for the hotel to comply with the brand standards of the new franchisor. Most franchisors require PIP improvements when a new franchise agreement is executed, particularly if the hotel was not previously operated under the franchisor's brand. These costs can be significant, and the lender or its affiliate or other purchaser at foreclosure should take all such costs into account before changing the hotel's brand. In re­branding, the lender or purchaser in foreclosure also will want to be sensitive to brand loyalty of customers and the economic consequences of re-branding, such as advance bookings for the hotel that might be tied to the existing brand.2 '

V. Renegotiating the Management Agreement.

If the management of the hotel is otherwise sound, the lender may be comfortable leaving the existing manager in place but may want to try to renegotiate some of the terms of the management agreement either pre- or post-foreclosure. For example, hotel management agreements often provide for the payment to the manager of "base management fees" and

2 See discussion in "Troubled Hotels and the Renegotiation of Management Agreements," April 28, 2007, by Irvin W, Sandman, in 4hoteliers,com.

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"incentive management fees". In connection with leaving the existing management in place, the lender may want to negotiate for a reduction in or a deferral of the base or incentive management fees, a change in performance standards or profit -based fees based on excess cash flow and/or revisions to the performance standards.3 The lender may also want to pursue other amendments to or rights under the management agreement, and the lender should carefully review the management agreement for economic provisions "buried" in the agreements, such as whether the management agreement permits the manager to require capital from the owner, and whether the agreement allows the lender to require items such as updated budgets.4 In addition, the lender should look for other provisions, such as radius restrictions, that could affect the lender if it takes over the hotel after foreclosure.

As noted above in Section ill.D., if a loan default occurs and management of the hotel is sub-par, the lender and its counsel will want to review the management agreement and the SNDA carefully for rights to terminate the management agreement either pre-foreclosure or post­foreclosure. Other provisions to look for are whether the manager is required to continue to perform under the management agreement if prior defaults by the borrower are not cured, what access the manager has to operating accounts and capital expenditure and other reserves and whether the manager is responsible for the hotel's payroll and employees (i.e., are the employees the employees of the manager).5

3 For these and other points of negotiation in management agreements, see, Sandman, supra. 4Id. 5Id.

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VI. Change of Hotel Ownership.

A. Change in Management: WARN Act.

Even a temporary or minor disruption in hotel operations can affect hotel revenues. Therefore, the lender will want to prepare with care before taking ownership of the hotel at foreclosure. As noted above, much of the value of the collateral for the hotel loan lies in the operating business. Even if the hotel is not re-branded and management does not change, the new owner will need to enter into new franchise and management agreements, and news of an impending foreclosure may cause the loss of hotel staff. If the lender plans to foreclose, as with most foreclosures, it obviously is better to proceed as swiftly as possible. In addition, the lender will need to have "shadow" management or a new manager in the wings to step in immediately if the lender or its affiliate is the purchaser at foreclosure. If there will be new hotel management, the WARN Act may come into play, and efforts will need to be made to offer employment to a sufficient number of employees to avoid WARN Act notification, which would not be beneficial to the continuing hotel operations.

B. Liquor and Other Licensing.

The hotel's liquor licenses may be in the name of the owner, the manager or both and/or any lessee of the hotel or beverage-company affiliate of the owner, manager or lessee. Liquor licensing procedures vary in each state, but liquor licenses are generally site specific and most liquor licensing statutes require re-licensing, and do not permit transfer of the liquor licenses, upon transfer of the property. For owners, managers and lessees with a track record with liquor licensing in the jurisdiction in which the hotel is located or even in other jurisdictions, the process may be relatively uneventful. However, if the lender or its affiliate or purchaser III foreclosure is unaccustomed to the

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fingerprinting, background checks, notices, etc. that may be required as a part of the license application, the process may be frustrating at a minimum and costly in terms of its impact on hotel operations if there is a lengthy delay in the hotel's ability to serve alcoholic beverages upon transfer of the property at or following foreclosure. For example, some liquor licensing laws require background checks up to the board of directors of the parent company of the licenseholder. Many companies, especially public companies, and in all likelihood most lenders, would be reticent to subject their boards to such an inquiry.

The impact of operating the hotel without a liquor license (and without serving alcoholic beverages) can be significant if the hotel has a restaurant that serves alcoholic beverages or a bar. As noted earlier, liquor licenses may be required for limited service hotels if the hotel only serves alcohol at a manager's happy hour and even if the hotel does not charge for the beverages. Where permitted under applicable laws, the hotel bar and/or other alcoholic beverage service may be continued under a "temporary beverage agreement" or "beverage transition agreement" pursuant to which the existing liquor licenseholder agrees to operate the hotel's bar, happy hour, etc. until the new owner and/or manager, as applicable, can obtain a new license. However, liquor licensing statutes frequently do not permit such temporary agreements, such agreements may be expressly prohibited or the liquor licensing statutes may be silent as to such arrangements. In addition, the licenseholder may be required to have an interest in the premises, which may require a lease of the hotel bar, for example, for operation during the interim licensing period.

The lender should take care to be knowledgeable of brand requirements for serving alcohol. Certain brands require a bar or other alcoholic beverage service for the hotel to be in compliance with brand standards. Accordingly, the lender should become familiar with the applicable liquor

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licensing requirements and brand standards prior to foreclosure and have a plan in place to deal with the licensing issues post-foreclosure.

c. Sales and Use Tax; Successor Liability.

Hotel owners and operators are liable for sales, use and occupancy taxes on the hotel's revenues and receipts. Such taxes usually are payable monthly depending upon applicable law. Such laws may also provide that a subsequent owner of the hotel has "successor liability" for such taxes if not paid by the prior owner. Such liability can sometimes be avoided if the tax authorities are given adequate notice, and it may be possible to obtain a tax clearance certificate from the applicable taxing authority if there is enough time before the transfer. However, such certificates frequently take many months to receive and are unlikely to be received before the foreclosure.

A prudent lender should engage in adequate diligence in the course of reviewing a troubled hotel loan. Hopefully, the lender has been receiving and/or has access to tax bills and tax payment records for the operations of the hotel to assist the lender in the evaluation prior to foreclosure of any potential liability for unpaid sales and use taxes, as well as other taxes.

D. Other Agreements and Licenses.

Many hotels depend upon other agreements, licenses and perntits for continued operation. The lender's review of a distressed hotel loan and/or preparation for foreclosure should include a review of all of the hotel's other agreements and licenses. These may include ground leases, parking agreements for off-site parking, agreements to expand the hotel, licenses for sidewalk cafes, restaurant, retail and other leases, restrictions and covenants and special use perntits, among others. All such agreements should be analyzed in

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connection with a transfer of the hotel at or following foreclosure.

E. Other Diligence.

In connection with review of a problem hotel loan and/or preparation for foreclosure, the lender and its counsel should undertake all additional diligence that would be prudent in the case of a foreclosure on other types of assets. Such diligence includes title and lien search updates and review, review of bankruptcy court filings, review of all 'loan documents and ancillary agreements, review of subordinate or mezzanine debt documents (if any), file review for current financial statements, budgets and other submittals required under the loan documents, etc. The prudent lender or its servicer hopefully has a well-documented loan file and well­structured loan documents that require the borrower to provide current submittals and to update lien searches and the like at the borrower's expense.

VII. Bankruptcy Considerations: Receiverships.

There are many issues that face a hotel lender if the borrower files for bankruptcy protection. An overview of two issues, rejection of the hotel management agreement and treatment of hotel revenues in bankruptcy, are briefly noted below.

A. Hotel Management Agreements: Rejection in Bankruptcy.

Even if the hotel management agreement does not provide for termination of the management agreement by the ownerlborrower, the agreement may be rejected as an executory contract under Section 365 of the Bankruptcy

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Code.6 In the lender's (and manager's) consideration of whether to amend the management agreement, the lender should note that the manager will be left with a potentially large unsecured damage claim if the ownerlborrower files for bankruptcy and rejects the management agreement, which may incentivize the manager to consider renegotiation of the management agreement?

B. Characterization of Hotel Revenues in Bankruptcy.

Even after the Bankruptcy Reform Act of 1994 (the "Act"), it remains unclear whether hotel revenues are "rents" or "accounts." The Act amended Sections 363(a)8 and 552(b)9 of the Bankruptcy Code to provide that the debtor can grant a security interest in hotel revenues before filing for bankruptcy and to define cash collateral as including "fees, charges, accounts or other payments for use or occupancy of rooms and other public facilities in hotels, motels and other lodging properties."l0 If the revenues of hotel operations are considered rents, a security interest in those rents can be perfected under applicable real estate law. If revenues are accounts, perfection would be in accordance with the Uniform Commercial Code as adopted in the applicable jurisdiction. Because of the lack of clarity, the lender would be well-advised to require filing in the land records as well as under the Uniform Commercial Code.

6 See 11 U.S.C. § 365. See also, Sandman, supra, for a discussion of bankruptcy considerations in connection with renegotiation of management agreements. 7 See Sandman, supra. 8 11 U.S.c. § 363(a). 9 11 U.S.c. § 552(b). 10 For a detailed analysis, including case citations as to the division among the courts, See Collier on Bankruptcy, Fifteenth Edition Revised, Section 363.03, et seq.

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C. Receiverships.

Most loan documents give the lender the right to appointment of a receiver in the event of a default. This right may be of particular interest to lenders with distressed loans secured by hotels. Given that a hotel is an operating business, it may be preferable to operate the property under a receivership to better assure continued operation of the hotel while the lender evaluates its options. The lender should pay careful attention to applicable receivership law in the jurisdiction where the hotel is located and follow all procedural and substantive requirements in connection with the appointment of the receiver and the operation of the property by the receiver.

Applicable law may require proper notice to creditors, posting of bonds, filing of a business or management plan, among other actions. Failure to comply with procedural and· other requirements may affect the validity of actions by the receiver, such as a sale of the property by the receiver. Court approvals of particular actions, such as a sale, may be required as well. Questions may arise as to whether the property can be sold by the receiver free and clear of liens, and applicable law should be consulted to determine if property can be sold free and clear by the receiver. Note that a buyer purchasing from a receiver will also want to confirm with its title company the requirements to insure title free and clear of liens.

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Conclusion.

There are a host of other bankruptcy, hospitality and lending issues that affect hotel loans and the workout and/or foreclosure of such loans after default. The foregoing is a brief overview of some of the issues and considerations. Additional attention should be given by the lender to the specific facts of each loan, and the applicable legal issues arising therefrom, in developing a strategy for resolution of a distressed hotel loan. Unfortunately, in times of overall market and financial stress, lenders may have many opportunities to consider all of these issues.

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