Mr. Norman is based in our Fort Lauderdale office.
"Look before you leap" is old, but good advice. These days, it certainly applies to lenders who are dealing with a wide range of hotel, resort, timeshare, fractional, branded residential and mixed-use projects that are in trouble, or might be described as having reached the category referred to as "failed."
For the lender, the path seems, on the surface, clear and obvious. It may be that the note has matured, or the loan is in default because payments are delinquent and all grace periods have expired. In a construction loan scenario, sales and completion milestones may have been missed and other loan agreement conditions, such as pre-sale requirements or opening for business, have never been satisfied. The market for unit sales has collapsed, and with discretionary travel spending in steep decline, it's obvious that there is little to no chance that debt service coverage ratios and other financial covenants – so carefully negotiated and documented in the loan agreement – will be met. To the best of the lender's knowledge, there is no credible defense to a foreclosure.
Most lenders will have already had candid discussions with their borrowers about the status of the project and the potential for paying off or refinancing the mortgage. It is unlikely that any encouraging news was forthcoming. Any objective look at the market suggests few sales, few advance group bookings, discretionary travel evaporating and resulting in major declines in all of the hospitality industry metrics, including gross revenues, RevPAR and net operating income. For construction lenders, take-out loans are nowhere to be seen.
This scenario would seem to provide the lender a choice between foreclosure and a negotiated deed in lieu of foreclosure with the borrower and possible participation of any guarantors. If only life were so simple!
Many Interested Parties, But No Clear Path
There are, indeed, other interested parties in this process. There is the brand manager or brand licensor, potentially other licensors such as a golf course brand and operator, project general contractor (for projects under construction or renovation) and in the case of condo hotels, timeshare, fractional and residential product unit purchasers. Part of the decision tree for the lender is how to deal with each of them and other parties in interest, as well as the crucial decision whether to finish the project, operate an existing project, or develop a strategy for resale to a new owner/developer. It is certainly not clear at this point in time (or anytime soon) that any of these alternatives are, or will be, economically viable.
If the loan is in default, it is likely that the license and management agreements for the hotel and the project amenities are also in default. The general contractor may have abandoned the project or has the right to do so. In any event, these parties will likely expect to be made whole if the lender wants to, effectively, take over the project either to a point of completion or to begin or continue operations. Lenders must ask themselves the ultimate question: "What do I do with this property if I take it back?"
Prior downturns have indicated that many borrowers will not "go gentle into that good night," but rather, will consider their legal options, such as bankruptcy or lender liability claims in response to foreclosure. It would also not be surprising to see claims from unit purchasers, foreclosure of construction liens and claims of priority over the lender's mortgage on one legal basis or another, depending upon the jurisdiction. Loan guarantors will also find a way to argue that they should be excused from their payment obligations.
So, apart from a straightforward decision of foreclosure or acceptance of a deed in lieu of foreclosure, the lender's process might better be described as "decisions, decisions."
Where To Start?
The first thing that a lender should evaluate is what special rights it may have, or limitations that exist on its ability to pursue a strategy, by virtue of project documents to which it is a party, or that which may impact the lender. In addition to the lender's own collateral security agreements with respect to major contracts, the Subordination, Non-Disturbance and Attornment Agreement between the lender and the hotel operator and related provisions of the management agreements and license agreements relating to the projects should be carefully reviewed. In addition, the lender's potential status as a successor developer in some jurisdictions should be evaluated from a legal standpoint to determine whether or not the lender's post-foreclosure strategy is one that can be implemented without undue liability to the lender. Other standard pre-foreclosure steps, such as title searches, appraisals and evaluation of potential for a quick sale or adaptive reuse should also be carefully evaluated with qualified consultants at this stage. A failure to do so could easily lead a lender into "a trap for the unwary."
Many Layers Of Complexity To Wade Through
Each potential path poses more questions than easy answers, and each has layers of complexity in determining the appropriate strategy for recovery of these unique assets as security for the loan, and then to the ultimate liquidation of the recovered asset.
In many situations, it may be better to leave the developer in place with a restructured loan, as long as other critical parties, such as the hotel's brand manager, agree to stay with the project. Loss of the brand, while not necessarily fatal, is likely one of those events which would significantly diminish the value of the asset. Preservation of the security itself and also of its present and future value are critical strategic decisions. Operating hotels, resorts and other hospitality projects is not something to which lenders are well suited. Pursuit of that course will require agreements with new parties and will generate significant post-foreclosure expenses for the lender. On the other hand, anything like a quick sale to a vulture fund will have its own negative impact on the lender, but in some circumstances, that may indeed be the best path to pursue if current cash is more essential than future potential pricing.
The bottom line is that the lender must make sure it has all of the facts and evaluated all of the possible issues and opportunities in the cold light of day before making a decision to proceed with foreclosure or a deed in lieu of foreclosure. Patience may not only be a virtue, it may also be a sound business strategy to avoid a major legal or business problem in this troubled economy.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
