Legal Briefs
Seeking Comfort
Hotel brands provide lender assurance — for a fee.
By Rori Malech |
When
providing loans on branded hotel properties, mortgage lenders usually seek a
“comfort” or “recognition” letter from the brand’s licensor or franchisor. A
comfort letter is a tri-party agreement among the owner, the lender, and the
licensor. Its purpose is to provide a lender with reasonable assurances that in
the event of a foreclosure, the lender will be able to maintain the hotel
brand’s license.
A Change
in Purpose
Prior to
the beginning of the economic downturn in 2008, the vast majority of lenders
providing hotel financing obtained comfort letters as a “check the box”
requirement. The letters provided “comfort” from the licensor that the lender
would have certain rights if the hotel owner defaulted under the loan
agreement.
However,
over time, comfort letters have shifted from protecting lenders to imposing
obligations on lenders and potentially exposing them to liability for the
benefit of the franchisors.
A hotel
with a national brand affiliation has either a license agreement, whereby the
name is solely licensed to the hotel owner, or a management agreement, which
states the brand is also responsible for the day-to-day management of the
hotel. In many instances, the brand is an essential benefit to the hotel that
the lender may want to preserve in the event it forecloses on the hotel.
Accordingly, lenders customarily require a comfort letter prior to or
simultaneously with the closing of any financing secured by a hotel.
Comfort
letters are issued by the brands on their standard form and are largely
non-negotiable; however, lenders that do a substantial amount of repeat
business with a brand may have their own negotiated forms. The primary benefits
of a comfort letter to a lender are the following:
- notice of owner defaults under the
license agreement and an opportunity to cure such defaults (usually coupled
with an additional cure period beyond the owner’s cure period);
- the right to enter into a new license
agreement with the licensor following a foreclosure; and
- the licensor’s waiver of the
application fee (and sometimes renovation requirements) when the lender enters
into such new license agreement.
In the
current market, in exchange for these benefits of the comfort letter, brands
have imposed onerous conditions on the lenders, including the following:
- before exercising a cure right, a
lender may be required to pay all fees due to the licensor from the licensee;
- before seeking appointment of a
receiver, a lender may be required to cure all licensor defaults in a
proscribed time period, provide a bond to guarantee the obligations of the
receiver, and negotiate a short-term interim license agreement with the
licensor for the receiver to operate the hotel during the receivership period;
- if a foreclosure follows a prior
license termination due to a licensee default, a lender may be obligated to
comply with the terms of the license agreement with respect to de-identifying
the hotel and to indemnify the licensor from any liability arising from the
operation of the hotel under the licensor’s brand; and
- the lender may be required to notify
the licensor in advance before exercising various remedies against the owner,
including commencement of foreclosure proceedings and a petition for
appointment of a receiver.
Lenders
often focus on the benefits they may get from a comfort letter without focusing
on the obligations imposed by the brand. Because the lender is not a party to
the license agreement, in the absence of a comfort letter, the lender is not
bound by any of its terms. Though the lender risks losing the brand in the
event of a foreclosure, if a hotel is well positioned in its market and the
licensor values the hotel, the lender will likely be able to negotiate a new or
interim franchise agreement whether or not it has obtained a comfort letter.
A
comfort letter puts the power in the lender’s hands to determine whether it
wants to maintain the license, but the conditions contained in a comfort letter
may bind the lender in connection with the exercise of its rights. Lenders must
weigh the benefits, including, among other things, the value of keeping the
brand in place, the waiver of fees and renovation requirements, and notice and
cure rights, against the obligations imposed on lenders.
Rori
Malech is a partner with Hunton & Williams LLP in Washington, D.C. Contact
her at rmalech@hunton.com.