Hotel Management Agreements

Baker & Mckenzie's View on Why Does the Manager Impose Restrictions on the Owner's Ability to Finance the Hotel - By Graeme Dickson and Kerrie Duong

The manager wishes to have the right to review the owner's financing to ensure that the owner's financing is prudent and the owner is not over-leveraged. Otherwise, the owner's financing default could result in the hotel being placed under the financier's control.

Baker & McKenzie

Avid readers of this newsletter will recall that Part 6 was devoted to non-disturbance deeds which bring the manager, the owner and its financier into contractual relations.

In this newsletter, we discuss other relatively common manager requirements with respect to owner financing. That is, why does the manager want to have a say in the owner's financing?

The manager wishes to have the right to review the owner's financing to ensure that the owner's financing is prudent and the owner is not over-leveraged. Otherwise, the owner's financing default could result in the hotel being placed under the financier's control. Managers are keen to avoid this circumstance as it would prefer not to have the financier as its de facto owner and would wish to avoid the potential brand damage and operational interruptions which may arise when a hotel falls under the control of the financier.

Managers typically seek to impose financing restrictions, which may include:

  • specifying the class of lenders from whom the owner can borrow;
  • excluding any lender which does not pass a "fit and proper" test as prescribed by the manager;
  • restricting the borrowing solely to the construction and operation of the hotel;
  • imposing a maximum loan to valuation ratio on the amount borrowed; and
  • imposing a maximum amount of interest payable by reference to forecasted hotel gross operating profit.

Owners need to give careful consideration to the ramifications of these requirements which may result in a contraction of the pool of available financiers and/or an increase in the cost of financing.

Owners should not only consider the ramifications of these requirements for their own purposes, but also the impact on any potential purchaser of the hotel, as reasonably onerous financing requirements may have an adverse impact on the hotel sale price otherwise achievable by the owner.

Typically, the owner and the manager will need to negotiate a set of reasonably balanced contract terms on this issue, which sometimes are embodied in a side letter specific to the current owner.

It is of supreme importance for financing matters to be competently negotiated and drafted, including an agreed form of non-disturbance deed if necessary. Advisors who do not possess appropriate expertise to advise upon and implement these provisions would have difficulty working out a reasonably balanced arrangement between the parties - and such advisors' lack of expertise could cost the owner dearly.

We would be happy to elaborate on this topic and the key negotiation considerations to any interested reader.

About Baker & McKenzie

Founded in 1949, Baker & McKenzie advises many of the world’s most dynamic and successful business organizations through more than 11,000 people in 77 offices in 47 countries. The Firm is known for its global perspective, deep understanding of the local language and culture of business, uncompromising commitment to excellence, and world-class fluency in its client service. Global revenues for the fiscal year ended 30 June 2014, were US$2.54 billion. Eduardo Leite is Chairman of the Executive Committee. (www.bakermckenzie.com)



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