The COVID-19 pandemic has affected the hotel industry like no other event in history. According to an American Hotel & Lodging Association (AHLA) report, eight in 10 hotel rooms across the U.S. are empty, and 70% of hotel employees have been laid off. Tens of thousands of properties across the country are closed or being used to house medical personnel and first responders. Some hotels are housing asymptomatic COVID-19 patients.
The pandemic has also raised a number of legal issues that hoteliers need to consider when closing their hotel; furloughing or laying off staff; and applying for government assistance in accordance with the Coronavirus Aid, Relief and Economic Security (CARES) Act.
Closing considerations
Most hotels that needed to close have already done so, but should the situation change or a second wave occurs, others may need to evaluate their situation.
“A temporary closure touches on virtually every area of law relevant to the operation of a hotel: labor laws; regulatory laws (federal, state and local); agreements with lenders; franchise, management and license agreements; general debtor-creditor relationships; tax law; and insurance law,” said Andrew Hogenson, a lawyer at the St. Louis office of Lathrop GPM.
Ron Rolleri, principal of Melville, NY-based Rolleri Law, suggested that hotel owners review their insurance policies to see how a closure may impact their coverage, or whether the coverage may offer relief in certain areas. “For example, does the policy have business-interruption coverage? This may offset some of the costs of the closure,” he said. “Ingress/egress coverage may apply when employees and guests are no longer able to enter the property due to an ‘insured peril.’ Similarly, civil-authority coverage may apply when a local governmental authority issues a mandate that prohibits access to the property.”
Rolleri also urged owners to review their contracts with suppliers and vendors. “See what can be canceled and/or modified,” he said. “If necessary, contact vendors to discuss credit terms, bills and any costs that can be delayed until the hotel is opened.”
Branded hotels will be guided by their brand as to if, when and how to close. “Many, if not most, major brands have systems and policies in place. These need to be known and followed,” said Hogenson. “In addition, if not specifically addressed in the policies, the owner needs to understand what brand services are continuing and what costs, if any, the owner will still be expected to pay during the pandemic, and what accommodations and waivers the brand may be willing to provide. The brand may agree to waive or defer fees, allowing the use of funds for operating expenses currently required for reserves or other purposes.”
Josh Bernstein, co-chair of global law firm Akerman LLP’s hospitality sector team, noted that topics to look out for in franchise and management agreements include “obligations to operate, the effect of a closure on the duration of the agreement, the effect of the closure on performance tests and any impact to the obligation to pay fees to the brand. Owners should also examine whether their agreements contain force majeure clauses and their impact on the obligations of the brands.”
Some of the larger brand operators are offering the following relief to owners: waiving or deferring payment of franchise/management fees; temporarily waiving the requirement that owners make monthly contributions to the FF&E reserve; waiving or reducing the requirement for owners to maintain a certain level of working capital; and suspending reputation management fees and guest relations handling fees.
Todd Soloway, partner and head of the hotel and hospitality group at the New York office of Pryor Cashman LLP, noted that from the owner’s side, “The primary issues are making sure they get an accurate reading on operating expenses and what their funding obligations will be going forward. The next issue will be when the hotel reopens and who makes that decision. There will be a lot of friction around this issue.”
Lee Eulgen, a partner at Chicago-based Neal Gerber Eisenberg and co-chair of the firm’s hospitality and leisure practice, offered, “Branded hotels—particularly in the luxury category—need to consider how to continue, and hopefully enhance, consumer engagement during this period of general closure,” he said. “Some brands have been doing an excellent job of using social media, email engagement and other means of community and consumer outreach to stay top of mind during this period. I think that they will really benefit from those efforts as the general economy starts to come back online. Brand connectivity is so important, especially at the higher end of the market. While the temptation may be to completely pull back on marketing spend right now, I think this presents a unique opportunity to make competitive gains.”
Loan obligations
When a hotel closes or occupancy is extremely low, hoteliers will have trouble fulfilling their loan obligations. It’s up to the owner to communicate with the lender to see what can be done.
“Hotel owners must have a discussion with the lender and consent to close, defer payments due under the loan and waive the covenants during the closure period and some ramp-up period,” noted Thomas Gryboski, partner in Morris, Manning & Martin LLP’s real estate development and finance practice and chair of the hospitality practice.
Soloway pointed out, “Most deals are focusing on deferral of loan repayment (as opposed to forgiveness). An additional issue that has arisen is the use of reserves (such as FF&E reserves) to fund operating expenses and, potentially, debt service. Either of these typically require lender consent.”
Hogenson noted that no lender is going to be surprised that a hotel is having difficulties meeting its loan obligations or may be in breach of its financial covenants. “While no specific assistance is guaranteed, the lender may agree to such items as deferral of loan payments, waiver of required reserves, financial covenants, and other affirmative and negative covenants, or may allow the use of all or part of the hotel property for other purposes,” he said, adding, “Existing loan documents almost certainly prohibit the borrower from obtaining additional loans without the lender’s consent, including loans under the CARES Act. Therefore, owners need to seek consent from their lenders in connection with obtaining these loans.”
Rolleri offered two options that a borrower can pursue: First, seek a forbearance, which is a deferral of payments of principal and interest. “Currently, many lenders of hotel loans are considering deferrals of 90 days,” he said. “However, lenders will likely ask for certain information, such as the property’s current cash position and burn rates. In addition, the lender will usually ask the borrower to enter into a pre-negotiation agreement, which is essentially an acknowledgment that both parties have agreed to enter into negotiations, and that nothing is binding until a final agreement is executed by both parties.”
Second, seek a loan modification or restructuring if a longer-term solution is needed. “Here, a borrower may seek a number of different modifications to the loan, such as a reduced interest rate, modification of financial covenants, reduced or deferred amortization and waived or deferred payments. Likewise, a lender may seek certain concessions from the borrower, such as a higher interest rate, additional collateral, a shortened period to loan maturity and additional reports containing information about the property.”
He added, “Borrowers should be aware of the tax implications of a forbearance or modification. Depending on the extent of the modification, a restructured loan may be considered ‘materially different’ from the original loan for federal income tax purposes, which could result in tax liability.”
Some owners may question whether force majeure clauses can lessen some of their obligations. “Force majeure is an important and crucial consideration with regard to ongoing obligations under management contracts, group-booking commitments, vendor engagements and other hotel and F&B-related agreements,” said Eulgen.
Bernstein pointed out that force majeure clauses can “delay the impact of performance tests under a management agreement, extend the time for an owner to perform property improvement projects and/or otherwise extend the time for an owner to bring a hotel into compliance with brand standards.”
However, according to Soloway, “The force majeure clauses of these contracts have been heavily scrutinized. This issue is very contract specific and language specific. The relief afforded to the party will depend upon the precise language employed, and this will also come into play when the government starts to lift restrictions. That may be viewed by the parties as the end of the force majeure event. We are sure to see disputes over this issue in the upcoming months.”
For Gryboski’s firm, “The only place we have seen force majeure as the basis for relief is in management contracts’ performance termination calculations. It seems like many management agreements have broad force majeure clauses, while loan documents and other agreements have narrow definitions that would not excuse performance based on a pandemic or national emergency.”
Rolleri advises owners to review the force majeure provisions in their contracts and determine to what extent they apply, and whether or not there are specific notice requirements. “Force majeure may come into play in a variety of different contexts. For example, hotel management agreements (HMAs) often provide for a RevPAR test,” he said. “In the event of a deficiency, the manager may be required to make a cure payment. Often, the contract will allow an adjustment to be made for an event of force majeure that has a material impact on the RevPAR test. Similarly, a force majeure event may impact the meeting of thresholds or tests for gross revenue, budgets generally or the conditions for the repayment of loans.”
Laying off/furloughing employees
Many hotels, whether closed or remaining open during the pandemic, have had to lay off employees. But it’s not as easy as handing out pink slips. The Federal Worker Adjustment and Retraining Notification (WARN) Act requires most employers with 100 or more full-time employees to provide 60 days advance notice of any site closings or mass layoffs.
“What constitutes a mass layoff will depend on the number of employees the employer has,” said Rolleri. “Notice must be provided to either affected workers or their representatives (e.g., a labor union); to the state dislocated worker unit; and to the appropriate unit of local government.”
Gryboski noted, however, that “temporary layoffs of under six months are generally not considered covered employment losses under WARN… If the hotel employs a unionized workforce, hoteliers should be aware of any obligations regarding layoffs that may be contained in applicable collective bargaining agreements.”
For his part, Soloway said, “The collective bargaining agreement will likely provide for the severance payments to be made and for other benefits. In New York, it was determined the Industry-Wide Bargaining Agreement didn’t provide for payment of severance for union employees but did provide four months of health coverage. However, if these layoffs become permanent, significant severance payments will be due.”
Owners should also be aware that some states have their own version of the WARN Act, with requirements that differ from the federal statute.
“For example,” Rolleri noted, “the New York WARN Act applies to employers with 50 or more full-time employees in New York State, and generally requires notice under the same sets of circumstances as the federal act, as well as for relocations and certain reductions in work hours. However, unlike the federal act, notice must be given at least 90 days prior to the triggering event.”
He continued, “Both the Federal and New York WARN Act recognize that businesses cannot always predict sudden and unexpected circumstances beyond the employer’s control, such as those presented by the COVID-19 pandemic. In such circumstances, a business must provide its notice as soon as possible, and include detailed information when filing its notice, including the circumstances leading to its closure, and a decision will be made as to whether an exception to the notice requirement applies. However, remember that individual state requirements may differ, and this exception may not be available in some states.”
The employer should also be aware of any state law requirements pertaining to what should be included in the employee’s final paycheck, such as unused vacation or sick time, or outstanding commissions or bonuses. “States may also require that the final paycheck be given by a certain date,” said Rolleri. “In addition, the Department of Labor and the IRS require employers to provide laid-off employees with their options regarding their 401(k) plan, if any, as well as continuing healthcare coverage under COBRA and any state laws providing for continuing coverage.”
If an employee is over 40 years of age, any release agreement must comply with the Older Workers Benefit Protection Act.
Rolleri noted that if the required WARN notification is not provided, the employer may be sued by the employee. “In addition, it is illegal to lay off an employee for discriminatory or retaliatory reasons,” he said. “Therefore, an employer should be able to demonstrate that a layoff of any particular employee or group of employees was due to legitimate business reasons, and not due to race, age, religion, natural origin, pregnancy, disability or another protected class, or in retaliation against the employee for previously filing a complaint of harassment or discrimination, or other illegal conduct.”
CARES Act and the Paycheck Protection Program
In March, President Trump signed into law the CARES Act, which provided roughly $2 trillion in emergency assistance and healthcare response for individuals, families and businesses affected by the pandemic. The legislation included payments for millions of Americans, unemployment benefit expansions and loans for struggling businesses. Within the act was the Paycheck Protection Program (PPP), $669 million in loans to help small businesses, self-employed workers, sole proprietors, certain nonprofit organizations and tribal businesses keep paying their workers.
On April 24, a $484-billion measure to replenish the funds to the PPP, among other things, was signed into law after the first round of funding ran out less than two weeks after the program’s initial launch.
“Hotels can take advantage of the CARES Act and SBA loan programs if they meet the employee number threshold or other size requirements,” said Hogenson. “For the SBA loan programs provided for under the act, the maximum employee amount is 500 unless an alternative number or size applies under the existing SBA rules.
“With respect to PPP loans, affiliation rules have been waived for hotels and, in addition, the threshold requirements are applied on a per location basis, all of which makes it easier for hotels to qualify,” he continued. “One issue associated with the PPP is that 75% of the loan’s proceeds must be used for payroll costs. Abiding by that requirement can be difficult if laid-off employees have moved on or are otherwise uninterested in returning. The existing Economic Injury Disaster Loan (EIDL) Program was also materially modified under the CARES Act. Unlike PPP loans, EIDLs require guarantees if the loan amount is more than $200,000, and the SBA will require collateral if it is available. Lenders and franchisors may be more hesitant to allow or may take more time analyzing a request by an owner to obtain an EIDL.”
Gryboski pointed out that hoteliers can access the PPP loans in the maximum amount of $10 million through existing SBA lenders or other lending institutions, adding, “We encourage owners to use their existing banking relationships as these funds are limited.”
According to Soloway, in order for a hotel to cover the 75% for payroll costs, it will likely need to rehire laid-off or furloughed workers in order to benefit from the program. “Even if reopening is not imminent, hotels may choose to rehire maintenance and housekeeping staff to perform preventative maintenance and to do a deep cleaning of all guestrooms and common spaces,” he said.
There has been some confusion about the CARES Act and, specifically, PPP eligibility from hotel owners who use a third-party management company to handle payroll obligations, noted Clifford J. Risman, partner in the Dallas office of Foley & Lardner LLP.
“The typical domestic hotel management agreement provides that even though the hotel owner bears the ultimate financial responsibility for payroll and other employment costs via reimbursement to the management company, the manager is the legal employer of the employees and is the party that remits the payroll taxes to the taxing authority,” he said. “A number of hotel company administrative affairs people, general counsel and other executives worked to educate the SBA on this industry mechanic and the unintended result of a literal reading of the act in this context. The intent was to cause the SBA to issue guidance stating that for purposes of calculating eligible loan amounts under the PPP, the party that ultimately bore the salary and related employment costs would be deemed to have incurred those costs even though they were not the party who remitted the payroll tax.“
He added, “Ultimately, the SBA issued some guidance that was helpful even though not directly on point. As a result, single-purpose entities that owned hotels felt more comfortable applying for the PPP loans and using the employment cost information provided to them by the managers, as having been reimbursed to the managers as their employment costs for purposes of calculating eligible loan amounts.”
Risman also pointed out that applications submitted to community banks and other relatively smaller financial institutions have been processed and approved much more quickly and efficiently than those submitted to larger money center banks.
Development and construction issues
The pandemic not only affected hotels already open, but development and construction projects were either slowed or put on hold. The spreading of COVID-19 has created a broad range of business and legal implications, noted Gryboski.
“The first step is to gather and organize relevant contracts for each project currently underway, such as contracts with architects, interior designers, engineers, consultants and contractors,” he said. “These should be reviewed together in order to evaluate COVID-19’s cumulative effect upon the project and to see if COVID-19-associated impacts are covered under any remedy-granting contract provisions and, if so, to what relief the impacted party may be entitled.
“It is important to note that some standard contract provisions may be triggered by COVID-19, including force majeure provisions, project shutdowns due to government orders, and the contracting parties’ suspension and termination rights,” he continued. “Other delay-related provisions that may apply in these contracts include provisions addressing claims for increased cost of the work due to labor shortages, limited availability of materials and equipment and price escalation.”
He added, “After the review, the owner/developer needs to determine the process for the affected party to file a claim, including how much notice must be given and whether claims are waived if proper notice is not given. Next, the owner/developer should consider what remedies may be available if applicable contract provisions are triggered. A few items to consider: Is the contractor entitled to an adjustment in the contract time, an adjustment in the contract sum, or both? Is there a liquidated damages provision that provides recourse for stakeholders in the event the contractor fails to achieve substantial completion as required in the contract?
“An owner/developer should review any restrictions for its use of any contingency funds that may be available and allow the contractor to offset some of the increased costs of construction resulting from COVID-19,” he said. “He/she should also evaluate remedies that may be available in the event the project suffers COVID-19 or other delay-related damages. For instance, he/she will want to determine if there is a complete waiver of consequential damages. If not, damages may be able to be recovered for lost rooms and events, as well as F&B, revenues and income.”
He concluded, “As the global community continues to grapple with COVID-19 and its impacts continue to evolve each day, its full effects on hospitality construction projects remain uncertain. Applicable governmental authorities are still determining if and when construction projects can proceed in the midst of the COVID-19 crisis. Hospitality owners and developer clients who cannot obtain a certain timetable for continuity of their construction project may want to consider exercising their contractual right to suspend the project or terminate for convenience in order to avoid project delay and interruption claims.”
If there is no force majeure, or it doesn’t address or include circumstances such as the COVID-19 pandemic, Rolleri noted that owners may be able to utilize a common law doctrine known as “Temporary Impracticality” or “Frustration of Purpose.”
“Depending on jurisdiction, this doctrine may apply when circumstances change a basic assumption under which the contract was made, so that performance under the contract has become impracticable,” he said. “Normally, the remedy here would be a rescission of the entire contract. However, that may not be what the parties want; what they may desire instead is a temporary pause without being in breach of the contract. This is where the theory of ‘Temporary Impracticality’ comes in.
“The theory has been used in times of national crisis, such as post 9/11 and after the 2008 credit crisis,” he continued. “Essentially, it means that a party’s obligation to perform during the period of impracticality or frustration is temporarily suspended, but not discharged completely. Thus, when the circumstances giving rise to the frustration or impracticality no longer exist, then the parties will be required to perform. It seems likely that the unprecedented events surrounding COVID-19 would provide an appropriate basis for asserting a claim of Temporary Impracticality, thereby allowing owners/developers and contractors to temporarily suspend their respective obligations without having to terminate the underlying contract altogether.”
A final word
Soloway said that owners need to have realistic expectations of whether their property will be viable in the event the pandemic continues to wreak havoc on society for a long period of time.
“Being able to weather a long period of low occupancy and revenues is going to require significant capital contributions,” he said. “Owners need to ask themselves: Is it worth it? And who has the right to decide when a hotel should reopen, and what are the associated capital requirements?”
Rolleri provided a last bit of advice: “Things are changing by the day, and the rules that have historically applied no longer do. We are all trying to adjust to this new normal while keeping our businesses alive,” he said. “Stay current on developments, which are occurring at record speed, and identify what might impact your business. Keep in regular touch with contacts and professional advisers. Decisions made today may significantly impact what happens down the road but, eventually, we will get through this.”
