COVID-19 has been devastating for the hospitality industry. Hotel occupancy rates are still well below normal. While some lenders are still granting relief to borrowers, lenders increasingly have been foreclosing on properties.
And finally, be prepared to explore other restructuring options if discussions with the lender do not provide the necessary flexibility to weather the pandemic-related distress and turn around operations.
First, it is crucial to proactively contact the lender well in advance of when the borrower will require lender relief. Waiting until the absolute last minute or simply ignoring a liquidity problem may limit the restructuring options available to a borrower. Without cash to fund operations, avoiding foreclosure becomes much more challenging.
But before the lender will engage, it will require the borrower to sign documentation saying that there is no agreement on modification, forbearance, or amendment of any underlying indebtedness unless and until both sides execute definitive written documentation.
For the borrower, negotiations with respect to debt restructuring must remain highly confidential. Foreclosures are a matter of public record and are picked up by local newspapers. Despite assurances by the hotel, few people will book a new event when they are concerned about the venue going dark or that existing events will be canceled. Plus, employees who fear loss of employment may be less enthusiastic about maintaining the quality of the property or guest services and enrichment. Publicity will devalue a property–to the detriment of both the lender and the borrower.
In asking for relief from a lender, the lender first will want to ascertain whether there was distress before the pandemic and whether those problems were amplified by the pandemic. Lenders (and bankruptcy judges, if it comes to that) will be less patient if the borrower was in a downward spiral before the pandemic but had done little to address liquidity constraints. Honesty goes a long way in discussions with a lender.
Second, the borrower must be prepared to present fulsome financial and valuation data to the lender–a task that can be difficult at best, given the various macroeconomic factors at play as a result of the pandemic. In evaluating a borrower's request for amendment or modification of the loan agreement, the lender will request, among other things, (i) prior period financial results, (ii) current cash position, (iii) occupancy rates, (iv) cash burn rate, and (v) both short- and long-term financial projections. A borrower should carefully work through its expenditures to identify areas for improvement or reductions as it presents a financial path forward to the lender.
Valuation is critically important. A borrower should distinguish the fundamentals of the property from the effects of the pandemic. COVID-19 presents a unique situation in which macroeconomic factors and their impact should be considered separately in the standard valuation analysis process. In valuation, it is necessary to understand the impact–and especially the timing–of macroeconomic factors on expected cash flows and on their present value. Projections will require the borrower to predict the pandemic future–a task made even more difficult by the delta variant's unpredictable impact on what appeared to be relatively normal summer and fall bookings, conferences, and other events.
As part of its diligence, the lender may hire its own professional advisor (at the borrower's expense) to investigate the borrower's true financial condition. A lender may also pressure a borrower to hire a chief restructuring officer to assist in addressing fundamental operational issues and/or cash burn. If the borrower has paid dividends or repaid insider/related party loans, the lender will view their recoupment of those payments as a source of liquidity going forward. And remember that errors and omissions in a borrower's presentation will cause the lender to be skeptical about relying on the borrower's action plan and valuations as negotiations progress.
On the lender's mind is the question of whether the borrower's proposal will yield the lender more money than a foreclosure will. The lender will take into account the length of time and the costs associated with foreclosure. State-specific law on foreclosure proceedings–i.e., whether the jurisdiction requires judicial foreclosure–will also carry weight in the lender's determination of how it chooses to proceed with respected to a defaulted credit facility. It also will consider the possibility of the borrower commencing a Chapter 11 case even if that topic is not broached during discussions. Lenders generally prefer not to go take ownership of a property. (However, sometimes loans are sold to persons whose motivation is "loan to own.")
Third, each party should demonstrate to the other that they are willing to do something beneficial for the other party in the financial restructuring. The lender will not make concessions unless it believes that the borrower is also willing to make concessions and has a realistic chance of restoring the loan to good standing. So, projections and a business plan that "prove" the need for relief and that the borrower can work its way out of the current predicament will be vetted thoroughly. A lender will see through a business plan and projections that merely hope the property's financial situation or occupancy rates will improve.
Lenders are more acquiescent when a borrower is willing to put more skin in the game in exchange for relief. This is especially true if the funds are to be utilized for capital improvements that increase the property's value.
Gaining a longer runway before any foreclosure proceedings are commenced can provide the breathing room a borrower needs to address pandemic-related distress resulting from reduced occupancy rates. In forbearance, the loan default is acknowledged, but the lender refrains from enforcing any remedies it may have under the loan documents or state law. During the forbearance period, a lender is likely to impose additional financial reporting requirements and fees on the borrower in connection with a forbearance agreement.
Restructuring debt to enable it to be serviceable can mean an extended loan maturity date, waiving certain material or nonmaterial defaults, interim reduction in the rate of principal amortization, an interim reduction of the interest rate, and/or a "bullet" or catch-up payment of deferred principal prior to maturity. If a borrower asks for interim relief and then fulfills what it has promised, further relief is more likely. But too short a forbearance time period can be counterproductive given that very little is likely to be demonstrable in less than 90 days.
If the current asset value is less than the debt and if the lender sees value restoration happening too slowly, it may sell the loan–which can be dangerous to the borrower if the loan is sold to someone who prefers ownership to repayment. A reduction of principal is possible, but only if the borrower can refinance and take out the lender for the discounted sum.
Although commencing a Chapter 11 bankruptcy case has the immediate benefit of automatically halting foreclosure proceedings for "single-asset real estate" debtors, the requirements for confirming a plan of reorganization make bankruptcy a less appealing but last-resort option. However, a positive of Chapter 11 is that the debtor's management team remains in place and continues to operate the debtor in Chapter 11.
Only certain hotel properties will qualify as single-asset real estate debtors. The elements of single-asset real estate are (1) the ownership of real property constituting a single property or project (2) that generates substantially all of the debtor's gross income and (3) on which no substantial business is conducted aside from operating the real property and related incidental activities. But typically, a hotel is not a single-asset real estate debtor if it provides services such as cleaning rooms every day, serving meals, maintaining a fitness center and swimming pool, operating a business or conference center, and providing laundry, internet, and phone services.
Forbearance may not be possible if a borrower is in default with multiple tranches of debt held by different lenders. In that scenario, a prepackaged Chapter 11 bankruptcy filed with the support of a lender or a group of lenders under a restructuring support agreement may be an option for a borrower.
Bankruptcy may not be a good option for a hotel borrower if there is a "bad boy" guarantee that allows a lender to recover against a guarantor–such as the debtor's equity interest holders–if the borrower commences a Chapter 11 case.
Bankruptcy requires cash or access to cash in order to fund administrative expenses during the case. Bankruptcy judges, like a hotel's lender, will expect to see a 13-week cash flow budget for the property. If the lender has a security interest in the cash proceeds of the business, the debtor will be required to obtain either the lender's consent or a bankruptcy court order approving the use of cash during the bankruptcy case.
The automatic stay (bankruptcy injunction) prevents a franchisor from terminating the franchise agreement in the event of bankruptcy filing–even if the franchise agreement says otherwise. As part of confirmation (approval) of a plan of reorganization, a debtor may assume or reject its franchise agreement. But in order to assume its franchise agreement, the debtor must cure pending defaults.
If a borrower is looking to slim down its real estate holdings or hotel portfolio, bankruptcy provides a platform for a sale to a third party under Section 363 of the Bankruptcy Code, while also permitting the borrower to restructure its existing debt.
State law may provide additional restructuring options for a borrower looking to avoid a bankruptcy filing. Look to state law on whether hotel revenue is rent, and therefore a security interest may be accomplished by an assignment of rent, or whether revenue is not rent and therefore must be secured under Section 9 of the Uniform Commercial Code. A lien search will disclose whether the lender has secured its interests in property revenue. If property revenue is unencumbered, a borrower may have the ability to find additional capital or a replacement lender, broadening the restructuring options available to a distressed property.
In any debt restructuring, the key to success is credibility. Lenders and bankruptcy judges alike will be more cooperative if they believe that the debtor's problems are attributable to macroeconomic factors beyond the borrower's control and that the relief sought from the lender is reasonable and also will facilitate restoration of the loan to be fully performing. A well-thought-out plan that provides for operational and/or financial improvements will help a distressed property weather the ongoing pandemic storm.
*The views expressed herein are those of the authors alone and are not necessarily shared by other persons at Lowenstein Sandler LLP. Each case is unique. The law is subject to interpretation.
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Kenneth A. Rosen
With more than 35 years of proven experience, Ken Rosen is the first call for companies seeking a strategic plan for recovery from financial distress. Mr. Rosen advises on the full spectrum of restructuring solutions, including Chapter 11 reorganizations, out-of-court workouts, financial restructurings, and litigation. He works closely with debtors, creditors' committees, lenders, landlords, and others in such diverse industries as paper and printing, food, furniture, pharmaceuticals, health care, and real estate. For each matter, Mr. Rosen starts by developing a strategic direction based on a clear understanding of his client's needs. His goals are to preserve the business or business relationship, to minimize disruption, and to move quickly toward a workable solution. His success is reflected both in his long list of accolades-including top rankings from Chambers USA (2008-2020) and The Deal's "Bankruptcy Insider"-and the fact that the majority of his practice is referral-based. Clients laud his practical approach and sensitivity to the needs of their business, as well as his strong track record of successful outcomes. Clients and peers alike recognize Mr. Rosen as "definitely a standout."
This article was co-authored by Jennifer Kimble, Esq. Ms. Kimble is a corporate restructuring attorney at Lowenstein Sandler with more than fifteen years' experience representing Chapter 11 debtors, creditors' and retiree committees, Chapter 7 trustees, and lenders in bankruptcy proceedings, preference actions, commercial transactions, commercial litigation, and out-of-court restructurings. She has extensive experience in all aspects of Chapter 11 cases, including first day motions, noticing issues, negotiating DIP financing, 363 sales, contract assumption, 1113/1114 matters, and plan confirmation and implementation. Ms. Kimble is skilled in claims resolution processes and well-versed in post-confirmation trusts and the litigation of Chapter 5 claims. She focuses her expertise on the mining, consumer goods and automotive sectors. Ms. Kimble currently serves as Vice Chair of the International Women's Insolvency and Restructuring Confederation (IWIRC) and on the Board of Directors of the American Bankruptcy Institute.