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The top ten decisions you need to make on hotel business sale agreements
Our experience in the buying or selling of hotels, whether it be in Australia or anywhere else in the world that we have done business, is that the same issues recur when making decisions about the sale process and then when drafting and negotiating your transaction documents. The purpose of this article is to examine some of the key transactional decisions that you need to make when buying or selling a hotel. Although we draw many issues from our Australian experiences, most of the issues are relevant to any jurisdiction in the world.
The top ten decisions that we discuss below are:
The sale or purchase of a single hotel asset or an entire portfolio is a complex, costly and potentially lengthy process, regardless of the scale of the transaction. However, it is possible to introduce significant efficiencies which can save time and reduce the complexity and cost.
There is no one element to which we can point as being solely responsible for a successful transaction result - rather, it is a combination of process design, considered drafting of the transaction documents and commerciality on the part of the vendor and the successful purchaser. We have used our considerable knowledge and experience to continually refine our services and bring innovation to the sale and purchase processes.
We do not suggest that the matters discussed in this article are by any means exhaustive of the issues that will arise during a hotel transaction, and some may not be directly applicable to your circumstances. What we have done is to share some of our experiences in important areas which, if not properly addressed, can increase costs, lead to price adjustments, or transactions being delayed or failing to proceed.
1. Structuring | Asset or Shares?
Fundamental to the design of many transactions is the desire of both parties to minimize adverse tax or cashflow consequences, whether those consequences arise from stamp duty, capital gains tax or a goods and services tax (GST) or other value added tax. While the impact of these costs will vary markedly between jurisdictions, they remain, in most cases, the first consideration of a vendor in deciding how an asset will be offered for sale, and for a purchaser in choosing how to acquire a hotel.
To a large extent where transfers of assets are involved, a purchaser will be restricted by the existing structures that are in place, unless they elect to pay potentially material additional costs to break from that structure. In the Australian context, one of the more common hotel ownership structures involves splitting ownership of the underlying hotel asset from that of the business. This is something which may need to be retained in an acquisition whether or not the purchaser has a need or desire to retain differentiated ownership in order to avoid the application of GST at a rate of 10% to the purchase price.
Structuring a purchase as a share sale will provide greater flexibility. In theory it should exempt the consideration paid from most tax implications other than stamp duty or other transfer fees payable on the share acquisition. Dealings with contracts and ongoing commercial arrangements at the hotel are also much simpler in these circumstances, as the contracting entity or entities remain the same before and after settlement. Provided that those contracts and arrangements do not contain restrictions on share sales, the time constraints that can arise from the need to obtain third party consents to assignments, are also substantially removed.
Both vendors and purchasers need to consider the following implications of share sales when evaluating the various transaction structures available:
In general terms, purchasers and vendors should each give considerable thought to potential structures that may be suitable for any one transaction that they are contemplating. A vendor who has at least considered a variety of acquisition structures, some of the possible issues associated with each one and anticipated what a purchaser may require, will be in a much better position to deal commercially with prospective purchasers.
2. Vacant or Managed | What's in a Name?
Generally, a hotel sold with vacant possession will attract a higher price than a hotel subject to an existing management contract. However, the ability to obtain vacant possession is becoming increasingly rare with the global trend towards longer management terms and even greater restrictions on an owner's ability to terminate operators on sale (other than where significant termination fees have been negotiated). In most circumstances it is therefore necessary to consider the terms and implications of a hotel management agreement before conducting a hotel sale process. Among the more common of these implications are:
On the rare occasions that vacant possession is available, in the Australian context the most immediate issue can become the requirement for payment of GST on top of the purchase price. This is because what is being purchased at the instant of sale may no longer a fully operating business (i.e. not a "going concern" for the purposes of Australian GST laws). Structures may be available to a purchaser to avoid this conclusion, particularly where a new management agreement is commencing from settlement. However, each matter needs to be considered in its particular circumstances, with relevance to the date on which settlement occurs and the timing for commencement of arrangements with the new or replacement operator.
Any proposed hotel re-branding exercise following completion needs to be carefully considered and planned for in the transaction documentation. While vacant possession may be available, the previous hotel brand websites, email addresses and associated details should ideally be acquired by the purchaser or held by the vendor for the purchaser's benefit for an agreed period of time following settlement, to allow existing customers and service providers to be transferred across to the new brand. Don't forget the basic issues such as the purchaser having a license to come into the premises and prepare for the removal and replacement of branding and signs immediately after settlement.
Purchasers may wish to resist paying for or taking ownership of branded stationary, bathrobes, bathroom materials and associated stock where vacant possession is being obtained. Care is required in crafting the definition of "stock". However, in most situations a vendor will similarly not be able to use these items after settlement and will seek to recover the value of those materials from the purchaser.
In vacant possession situations, it becomes particularly important for a purchaser to bind the vendor to ongoing obligations with respect to operation of the hotel business (and procuring the operator to act accordingly) between exchange of contracts and settlement. This is more likely to be an issue with smaller operators who, in those circumstances, may not have the same incentive to continue operating the business at optimum levels, once termination rights have been exercised.
3. Due Diligence | Scope and Planning
Ultimately it is the extent, adequacy and availability of due diligence information which can determine the success or otherwise of a hotel transaction. In our experience, the most successful transactions are those which have the most extensive and complete due diligence information available, with respect to the underlying hotel asset, business and operator, before a purchaser begins substantive due diligence.
While prospective purchasers can and do have a role in improving the standard and coverage of due diligence information after the process has begun, responsibility for preparing and offering this information to market rests with the vendor in the first instance. This requires detailed planning, interrogation of key hotel personnel and collation of materials relevant to the hotel in an organized and easily digestible form. In our own practice, we begin such a process with a detailed checklist broken down into real property, business and corporate areas, which the vendor then uses as a prompt to compile the relevant categories of information and ask the appropriate questions of the operator, staff and consultants.
A well-designed data room will be coupled with rules regulating access to and dealings with those materials. Matters as simple and detailed as the form and manner in which questions or requests for information can be asked by purchasers and their consultants and the timing that can be expected for responses to those questions, can greatly contribute to streamlining due diligence processes.
Confidentiality will be extremely important to vendors during this process, and access to a data room will usually only be granted once an appropriate confidentiality deed has been signed. The negotiation of these deeds can occasionally become an expensive and time-consuming road-block to a transaction, increasingly so where many prospective purchasers are asked to sign such a deed at the early stages of due diligence. It is important to streamline and standardize this process and if possible avoid using overly complicated or lengthy deeds.
Particularly in competitive tender situations, parties should also consider running (or requesting) a formal briefing session at some time after the first issue of the draft transaction documents. By this stage, substantial due diligence should have already been completed and the session can be used to discuss key concerns, the general approach taken in the transaction documentation and the expectations that the vendor will be applying to each of the bidders with respect to final bids.
Imposing sensible levels of materiality on this process is fundamental. Depending on the size of the assets being sold, a vendor may choose, for example, to disclose every relevant document or piece of correspondence, but only undertake to respond to purchaser requests for information if they relate to matters worth in excess of a certain amount or say, agreements with a remaining term in excess of 12 months. Both purchasers and vendors should seek to impose materiality restrictions on their own investigations and the extent to which they will pursue, query or ignore issues that are deemed to be non-material. This will have a direct impact on the cost and timing of a transaction and, ultimately, the level of detail and negotiation required in order to settle the transaction documentation.
4. Warranties | None, Some or Kit and Caboodle?
Among the more hotly contested sections of any transaction document, warranties can be a significant sticking point in a hotel transaction. The starting point depends largely on the commercial aspects of the transaction, the desirability of the asset and the timing within which a deal needs to be completed. Without any of these constraints, a vendor's ideal position is to give no warranties at all and a purchaser's to have both the opportunity for full due diligence and then everything, even-marginally relevant to the asset, subject to a warranty. This however, does not reflect the real world.
No matter how extensive warranties may be, a claim for breach of warranty is not only dependent on the original vendor still being in existence and having sufficient assets to pay, but without vendor cooperation it will almost always require expensive court action to enforce, and therefore be justified in only the most material of circumstances.
Warranties should really only be pursued for matters which are considered by the purchaser to be material. A purchaser would in most cases be well advised to pursue full disclosure on a particular issue and understand the extent of that issue, rather than simply rely on a warranty in relation to it. Once the issue is understood, a warranty may still be sought regarding a limit on its financial impacts, but this is done from an informed position rather than seeking general warranties to apply across the spectrum of hotel operations.
That said, parties quite rightly seek much broader warranties in a situation where insufficient due diligence material or opportunities for inspection of that material have been provided. It is more difficult for a vendor to refuse to grant warranties in a situation where the purchaser has been provided with only limited opportunity to make their own enquiries or to inspect records and information relevant to the hotel.
Similarly, where a vendor has provided quite detailed information to a purchaser on which they have relied in deciding to proceed with their investment, a vendor may be requested to provide a warranty with respect to the due diligence information itself - usually that such information is complete, correct and accurate in all respects.
5. Inclusions and Exclusions | What's Really for Sale?
There are two aspects to this question, both of which appear simple but which actually lead to quite a bit of confusion and post-settlement disputes in many hotel transactions:
Ideally there will be an up-to-date hotel asset register which accurately records all of the FF&E. In practice, however, such a resource is almost never available and a purchaser needs to rely on its own investigations and the disclosures or undertakings of the vendor in the transaction documents. Where ownership of assets is split between the owner of the hotel and the owner of the underlying business, it becomes even more important to accurately identify where ownership of assets lies.
Items owned by the operator are most significant in vacant possession situations - failure to identify the fact that the hotel owner does not actually own the beds in the hotel can lead to some serious issues when possession is handed over and the operator takes its property away! Obviously these considerations also become relevant for the purposes of valuations.
Hotel owners and operators themselves often don't know (or in many cases have simply forgotten with the passage of time or changes in staff) that third parties own equipment or materials used in the day-to-day operation of the hotel. If these are not correctly identified and dealt with in the sale process, a purchaser can find themselves needing to acquire replacement assets or enter into new agreements at significant cost after settlement. Some of the more common examples that we have come across are:
6. Hotel Services | Access Rights and Other Issues
When dealing with hotels or indeed any type of real property, both vendors and purchasers commonly assume that the visible access paths to the property, whether by way of stairs, roads or pedestrian walkways, are either all within the ownership of the hotel or else are covered by appropriate legal rights to allow such use.
Many hotels are affected by agreements relating to the sharing of electricity, water and other services (particularly in mixed use developments), and providing for access to the hotel over Council-owned or third party land. In most circumstances, these agreements were entered into on construction of the hotel and may have been subsequently overlooked or forgotten. From a purchaser's perspective, unless these agreements are specifically disclosed, it is often only by conducting a survey of the property and considering the location of the services used by the hotel) that issues relating to access and services can be identified and raised with the vendor.
Some examples of issues with access and services are:
The key to any of these scenarios is that appropriate preparation by a vendor or due diligence by a purchaser will be able to identify these issues at an early stage and avoid them arising during some of the more crucial commercial negotiations on the transaction documents. Where approvals are required for assignment of existing access agreements, the timing for securing these approvals needs to be built into the overall timeline for the transaction.
Despite all of the above, it is important to recognize that in some cases a solution to a particular issue may not be available, but these issues are precisely the ones which a vendor should identify and prepare for in advance so that they can be explained to a purchaser and a decision can be made in regard to the risk.
7. Employees | A Minefield of Options
Employee responsibilities and adjustment of employee expenses is one of the greatest costs associated with hotel operations and dealing with employees and their rights and entitlements is important. Care is required to ensure that the relevant transmission of business rules will properly apply to protect an incoming purchaser and outgoing vendor from employee claims for termination (and resulting redundancy payment obligations) that might otherwise arise on sale. This generally means that discussions in hotel transactions with respect to employees centre around two key areas - the adjustment of employee benefits and liabilities, and the purchaser's obligations with regard to offering employment to transferring employees.
There are a number of different categories of adjustment with respect to employees, some of which are always adjusted, some of which are rarely adjusted, and others which vary on a transactional basis. Of course, one way to avoid employee adjustments on a sale altogether is for the vendor to terminate all employees and pay out all remaining liabilities, with the purchaser then employing those employees afresh from settlement. Such a course of action would rarely be followed, however, as a number of additional costs and liabilities may arise, depending on the particular employment contracts and industrial instruments that apply. In general the categories of adjustment (some of which are more commonly adjusted than others) can be broken up as follows:
The discussion in relation to a purchaser's offer of employment to transferring employees is much more straight forward. Employment offers need to be made in such a way as to ensure that employees cannot claim they have effectively been made redundant. In Australia, the basis of this is that an employee is offered a job on generally equivalent terms to their employment before the sale, but vendors often seek to impose a higher standard on purchasers in order to provide some protection against redundancy claims by employees.
There can be substantial differences between a purchaser being required to offer employment to existing employees on "generally equivalent" terms and "equal or superior" terms, and purchasers will usually seek to avoid the latter requirement.
8. Post-Exchange | Passing of Risk, Hotel Operations
Simultaneous exchange and settlement of contracts involving the sale of a hotel are not common, and there will usually be a period following exchange during which various preconditions under the contract are satisfied, adjustments are calculated and the purchaser otherwise prepares for acquisition of the hotel.
In some jurisdictions, including a number of Australian States, a standard starting position is for a vendor to try and assign all risk of the hotel to the purchaser on the date of exchange. This means that a purchaser needs to have insurance in place from exchange and may be liable to comply with statutory notices issued with respect to the business, or other risks affecting the hotel, prior to the date of settlement. This position is rarely accepted by purchasers unless they are to have some active role in the business operations during this period or, for example, are preparing a new manager to take over the hotel from settlement, in the case of a vacant possession purchase.
In most circumstances, the vendor retains the risk but the parties may agree that certain matters, for example the issue of a statutory notice requiring significant capital works, may need to be jointly complied with by the vendor and purchaser. A purchaser's main concern during this period is that the hotel continues to run in accordance with standard practices and that the standard of the hotel business and assets remains at completion the same as at the date of exchange of contracts, subject only to fair wear and tear,. This concept is reflected in varying forms in most transaction documents, with one of the key areas of dispute relating to the extent to which a vendor is required to replace or repair items in the hotel which fail, break down or are damaged beyond the standard of fair wear and tear during this period.
In other areas a purchaser will, quite rightly, seek to maintain a level of control over granting new contracts, carrying out capital expenditure works on the hotel, hiring new employees and other material business decisions made after exchange, that it may be required to inherit or adjust for on settlement. The variation in these arrangements generally centers around the monetary value of decisions above which the purchaser's consent is required, timing for the purchaser to issue a response, and whether or not a purchaser's discretion in this regard is absolute or in the form of a consent which cannot be unreasonably withheld.
9. Adjustments | Timing, Arrears Collections and Books
In a similar vein to employee adjustments, adjustments at the broader hotel level (and we are talking here about hotel business adjustments, not the more straight-forward asset adjustments relating to land tax, rates and the like) can be complex and vary from one transaction to the next. The structure of the particular hotel business and the extent to which the hotel business owner takes an active role in supervising and calculating hotel expenses, will also affect the way in which these adjustments are carried out. For simplicity, we have set out below a number of bullet points representing the common questions that need to be asked about adjustments, together with some of the primary heads of adjustment that we see in most, if not all hotel transactions:
10. Disputes | Think Ahead
As a final and brief point, parties often either assume a sale process will flow smoothly once contracts have been exchanged, or at the other extreme, assume the worst and that in the case of any dispute, they will simply proceed to court.
The reality is, there will almost always be matters under a contract about which the vendor and purchaser have some form of disagreement, and there should be an appropriate mechanism in the contract documentation to deal with that situation. Such clauses and the process of parties negotiating and agreeing on their content, provide a strong disincentive from disagreements escalating to the point that the clauses are actually activated.
One of the most practical techniques in this regard is to build into a dispute resolution clause a requirement for the parties to refer any matter deemed to be an official "dispute", to the CEO or General Manager of their respective organizations. This should be a required first step before the involvement of a third party expert or any ability to take the dispute to arbitration or into the Court processes. In practice any issues which do not have material financial impacts will be negotiated to a resolution rather than taking them to such a senior level.
Obviously there will be some matters, particularly in relation to adjustments, which require input of a technical nature and which may not otherwise be able to be agreed between the respective senior officers. To the extent an independent expert is then given the ability to determine that dispute, parties need to decide whether that decision will be final and binding or capable of appeal to the courts. An appropriate middle ground may be to make all decisions final and binding except for those which have a financial impact in excess of a significant amount of money, at which stage parties can elect to appeal that decision, provided such election is made within a defined time period.
This publication has been prepared for the general information of clients and professional associates of Baker & McKenzie. You should not rely on the contents. It is not legal advice and should not be regarded as a substitute for legal advice. To the fullest extent allowed by law, Baker & McKenzie excludes all liability (whether arising in contract, for negligence or otherwise) in respect of all and each part of this document, including without limitation, any errors or omissions.
©2008 Baker & McKenzie All rights reserved.
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