The Why, What and How of Hotel Receiverships

By: James M. McGee, Joseph J. Wielebinski

Jun 16, 2009

Hospitality & Mixed-Use Leader 

After 9/11 until the beginning of the current financial meltdown in 2007, the hotel industry experienced an almost unprecedented boom in new development financed by low interest rates and easy credit. The recession and credit freeze has strained financial operations — cutbacks by business and pleasure travelers lowers occupancy rates, forcing competition and lowering average daily room rates (ADR’s), creating a "double whammy" to revenue. A recent PricewaterhouseCoopers presentation summed this situation up by its title: “The Worst REVPar [revenue per available room] Environment of Our Lifetimes,” predicting that REVPar will be down 11.2 percent from 2008 to 2009. For hotels that were financed with long-term permanent loans, the dramatic change in their finances may cause revenue to be insufficient to cover even operational expenses, much less debt service, putting the loans into default and the hotel at risk of going dark. For hotels that are under construction loans, the lack of liquidity in the marketplace coupled with the reduction in operating revenue will make securing a permanent takeout loan extremely difficult. Many market analysts predict that the hotel industry faces a mountain of impending loan defaults. In the securitized mortgage arena, which only represents a fraction of hotel lending, more than $30 billion of commercial mortgage-backed securities were issued for hotels in 2006 and 2007, many of which are maturing this year. Renewing or extending these loans will be virtually impossible.

Why a Receivership?

Although a hotel looks and feels like any other real estate asset, the physical hotel is really a services-delivery location, more similar to a restaurant than a warehouse, office building or apartment complex. This service aspect, coupled with liability issues associated with areas like food and alcohol sales and valet service, significantly reduce lenders’ desire to directly deal with the asset through foreclosure or other means of recovering on their collateral.

As long as the borrower and hotel operator are operating the hotel efficiently as compared to its competitive set of hotels and are otherwise maximizing revenue and applying that revenue to the loan, most lenders are willing to forebear from exercising their legal remedies or extend maturing loans instead of putting the property/collateral through the turmoil of the various loan enforcement options. However, if the lender is not comfortable with the borrower/operator’s ability to operate the hotel or feels that the borrower is wasting the lender’s collateral (not applying revenue to loan payments, taking personal property, etc.), the lender, although not wanting to take possession of the hotel, may determine that it needs to wrest control away from the borrower — which is where hotel receiverships come into play. A lender’s decision to seek the appointment of a receiver instead of foreclosing (or in the event of extended delays in judicial foreclosure states during the foreclosure process) is typically motivated by a stagnant market where a quick sale is either unlikely or will be at a substantially discounted price or by the lender’s belief that proper management could result in enhanced operational performance. The lender may have other reasons for preferring a receivership, such as distancing itself from potential liabilities (e.g., environmental problems, health/safety concerns, etc.).

In addition to a lender requested receivership, the owner/borrower may seek the appointment of a receiver if it does not operate the property and determines that the property’s distress is caused by current management. In the hotel context, most receivers are hotel management companies (or in states like Texas that require that individuals be receivers, officers at hotel management companies that hire their management companies to manage the hotel asset). The purpose of this article is to outline the basics of hotel receiverships for borrowers, lenders and management companies.

What is a Receivership?

A receivership is a state court proceeding governed by state law. A receiver is an officer of the court holding possession of the property for the court that appointed the receiver. As a general matter, a “receiver” is a neutral person or entity placed in an intermediary role between the parties to receive rents the profits from the asset where it is not reasonable that either party to the litigation should be the operator. In most cases, the secured lender seeks and nominates the receiver. The receiver owes its allegiance to the court that appointed the receiver, but may owe fiduciary duties to each of the receivership estate’s constituents (e.g., the owner, secured lender and trade creditors).

As an extension of the court, the receiver’s powers are, generally, limited to the powers granted to him or her by the court. The scope of that power is outlined in the court order appointing the receiver. The content and scope of that order is critically important to all parties involved and is the linchpin to a successful receivership or a costly, delay-plagued receivership. The order appointing the receiver should be as broad as possible and encompass prior court authority for all operational needs and any special or unusual power the receiver anticipates needing. This will typically provide the receiver with the power and authority to conduct operations without continually requesting court approval, thus providing the receiver the necessary flexibility to react quickly to anticipated situations. These powers should include, at a minimum:

  • ordering the debtor/owner to turn over all books, records, bank accounts, check books, keys, codes, contracts and licenses;
  • the power to open new bank accounts;
  • the power to retain counsel and, as mentioned above, a management company;
  • the power to enter into necessary service provider agreements such as utilities, security and employment agreements;
  • the power to collect revenue;
  • the power to make necessary repair and maintenance expenditures; and
  • payment to critical vendors.

Unlike a "workout," that may preserve the status quo while giving the owner/borrower more time (typically at a higher rate of interest) to pay off a loan when it becomes due or that may change the owner/borrower’s monthly mortgage obligation (again, typically with some long-term increased expense) in order to keep the doors open, a receivership divests the owner/borrower of control. Unlike a bankruptcy that may allow the owner/borrower to stay in control and that will relieve the owner/borrower from at least some of its burdensome obligations, a receivership usually preserves the status quo, including most of the owner/borrower’s obligations.

Each jurisdiction has very specific and widely different requirements to qualify as a receiver. In certain jurisdictions, a corporate entity and/or individual may qualify to operate as a receiver. In other jurisdictions, such as Texas, a receiver must be a citizen of the state of Texas and a qualified voter at the time of the appointment (thus, an individual person).

Before assuming the duties of a receiver, the person or entity appointed as a receiver must, in most jurisdictions, execute an oath to perform the duties faithfully and provide a good and sufficient bond.

When is Receivership a Good Option?

Whether a receivership is the best option depends on the situation; it is a factually intensive analysis and depends on whether you are a lender or borrower. For instance, consider two scenarios common in the hotel industry. In the first scenario, the cause of the hotel’s distress is purely the state of today’s economy and the current operator (whether the owner or a third party management company) is highly capable and acting prudently. As mentioned above, in this case, a receivership would be pointless because the main purpose of the receivership is to wrest control from the borrower and make management and other necessary changes while the lender determines what remedies will be exercised. In the second scenario, the cause of the distress is the management and a receivership could benefit both the lender and the owner/borrower because the receiver could bring in new, more competent management to make necessary changes to enhance the profitability and value of the hotel asset.

How will the Appointment of a Receiver Impact All Parties Involved?

The impact of the appointment of a receiver varies depending on the situation that required the appointment, the hotel itself, the content and scope of the court order appointing the receiver (and thus, the receiver’s powers), and the relationships between the owner/borrower, manager, and lender, whether dictated by contract or otherwise.

Of interest to all parties involved is the receiver’s impact on pre-existing contracts, rights, duties and liens. In a nutshell and as a relief to the non-owner/borrower parties, the appointment of a receiver does not affect title or determine rights to property (in fact, the receiver does not take title to the hotel or other property of the owner/borrower even though the receiver does divest the owner of possession of the hotel and related property), destroy or affect vested rights, affect the order of existing liens or destroy any liens. Additionally and unfortunately for the owner/borrower, the appointment of a receiver has no impact on the recourse or non-recourse nature of any liens against the hotel or any other obligations under the loan documents or guarantees executed by the owner/borrower.

However, the appointment of a receiver may impact executory (e.g., incomplete contracts), thereby greatly impacting the hotel’s vendors and other parties who provide services to or for the hotel, including the property manager. A receiver may (generally with court approval) repudiate or reject executory contracts. Nevertheless, the rejection of executory contracts will give rise to damage claims against the owner/borrower similar to the claims created by the rejection of executory contracts in bankruptcy, which is very important in examining whether to terminate the hotel’s flag or existing third party management contracts. The secured lender may not be overly concerned with such claims, however, as these claims will be unsecured and/or subordinated to the lender’s lien on the hotel assets, and ultimately, the foreclosure of the property will eliminate these claims. However, if the lender has a large deficiency claim, the receiver in making this decision must keep in mind his duty to the borrower, secured lender, and all unsecured creditors and other claimants.

A receiver may be authorized to enter into a contract. Yet, the receiver should not enter into a contract, particularly one of any magnitude or one which extends beyond the term of the receivership, without the authority or approval of the appointing court, unless specifically permitted by the order appointing the receiver.

Generally, a court has jurisdiction to order its receiver to make a sale or disposition of the property in receivership. The receiver should propose appropriate procedures for disposition of the receivership property, and in the case of the sale of the hotel or any other major asset of the estate, the receiver should consider engaging other experts such as real estate brokers to establish the most expeditious, efficient and productive sale procedures. For the reasons previously mentioned, the procedures should be approved by the court. It is important to remember that in most jurisdictions, property in the hands of a receiver may be sold, even through foreclosure by a secured lender, only with prior court approval.

Finally, some of the impacts of the appointment of a receiver are unknown because recent management agreements and loan documents may contain provisions that purport to affect the impact of the appointment of a receiver (e.g., forbidding voluntary actions by the borrower unless outside directors vote in favor of the action, providing that receivers and bankruptcy proceedings result in springing guaranties against principals). These provisions are relatively new and it is uncertain how the courts will interpret and enforce these clauses. Pertinent to receiverships, some management agreements contain “non-disturbance clauses” that limit the circumstances upon which the property manager may be removed. These clauses could limit the receiver’s ability to remove the property manager, thereby limiting the receiver’s control over the hotel and its operation.

Receiver’s Potential Liability

The liability of receivers is generally in their official and not personal capacity. The receiver is an officer and arm of the court and acts under the direction and with the approval of the court; as such, the receiver has only very limited powers and should apply to the court for advice and direction and, if the receiver acts without court authority, he or she assumes the risk of liability for cost and expenses incurred. However, where a receiver, appointed by the court, acts within the court’s orders, the receiver shares the court’s immunity from liability. Personal liability of a receiver arises from wrongful, negligent or other acts not within the scope of its authority as determined by the statutes and order and directions of the court.