Recently one of my partners asked me to review an SNDA signed by a reputable real estate lender. This time, the lender really stepped in the goo. The lender had agreed to ensure that the brand's management rights under its hotel management agreement would be protected even if the hotel were sold to a third party who over-bid the lender's credit bid at a foreclosure sale. Of course, this continuing obligation was not spelled out in such a forthright manner. But that is exactly the result when you string together various provisions of the SNDA (the brand's form) together with the terms of the hotel management agreement (also the brand's form).
In other words, despite the opening paragraphs that provide the lender's lien is senior to the management agreement, foreclosure will not cut off the hotel management agreement as it does with most junior encumbrances. Unfortunately, this lender will soon be writing a large check to the hotel's operator, and the hotel's value is severely reduced. In fact, in this case, it appears that the property would sell for double its likely sale price if it were "unencumbered" by the long-term management agreement.
This was not the first time, nor will it be the last, an unwitting real estate lender mistakenly treated a hotel loan like a real estate loan. This particular lender has a long history of real estate lending, and has even made some high-end hotels loans. But it is clear that the lender and its legal counsel are not sufficiently knowledgeable about hotel lending. They do not understand how the SNDA and hotel management agreement work together, nor do they really understand how the hotel operates. In this case, what they didn't know cost them a bundle.
Fortunately, hotel lenders can avoid such expensive blunders.
What the SNDA does
The SNDA is frequently used when someone other than the owner is occupying or using the real property secured by the lender's loan. In the hotel industry, this involves the hotel owner, the hotel operator and the hotel lender.
When a hotel lender grants "non-disturbance" rights to a hotel operator, the lender is agreeing that if the lender ever seeks a receiver or acquires control over or title to the property by foreclosure, deed-in-lieu of foreclosure or otherwise, it will recognize and accept in its entirety the hotel management agreement in the same manner as if it were the hotel owner. Often, the hotel lender feels compelled to accept the SNDA and to grant non-disturbance to a hotel operator -- otherwise the hotel owner will seek financing from another lender. Therein, the foible lies. Once the hotel lender agrees to be bound by and to honor the hotel management agreement (including the SNDA), many terms of the loan documents are modified to the severe detriment of the hotel lender.
Prudent lender precautions
A prudent hotel lender will take precautions to ensure that the hotel documents provide the lender with certain necessary protections, such as the following:
- Subject to the covenant of non-disturbance, the hotel management agreement will be subject and subordinate to the lender's rights under the loan documents.
- Where the hotel operator or lender has a termination right on foreclosure, the hotel operator will cooperate with the hotel lender in the transition of mnagement, including back office systems, marketing, employees, licenses and credit card processing, as applicable.
- The hotel lender will not be saddled with the owner's obligation for unpaid management fees to the hotel operator.
- The hotel lender will have the right to approve changes in the hotel management documents and operations.
- The hotel operator will not exercise its remedies upon owner's default until the hotel lender has had sufficient time to transfer the title to the hotel to a buyer, or at least will provide the lender with the ability to cure (as a last resort).
There is a tension between a branded hotel operator's concerns over maintaining the quality of its brand in the face of an owner default and the hotel lender being able to transfer the hotel without incurring significant costs in the process. It's not that the hotel lender believes the brand has any particular intrinsic value in these cases. After all, if the hotel is in default, it's usually because the hotel is not cash flowing well enough to support the brand, which can be unattractive to a prospective buyer. The flipside is, if the branded hotel operator terminates its management agreement, the hotel lender may end up bearing the expense of de-branding the hotel, which can be quite costly. It's a balancing test, and each circumstance must be judged on its own merits.
If a hotel lender is forced to recognize the hotel management agreement post foreclosure, the rights and remedies of the lender and hotel operator become quite complex. The hotel lender that ignores the complex elements of the hotel management agreement up front may find a rude awakening when it comes into title.
Hotel lending lawyer series - What every hotel lender needs to know
There are a lot of hotel-specific issues that hotel loan documents have to deal with. This series is designed to provide the essentials: