<p>From PLI’s Course Handbook Hotels 2009: Acquiring, Managing, Developing & Financing a Unique Property Type #18140</p><p>14</p><p>HOSPITALITY WORKOUTS AND RESTRUCTURINGS IN 2009</p><p>Peter D. Connolly Connolly & Co. HOSPITALITY WORKOUTS AND RESTRUCTURINGS IN 2009</p><p>I. Introduction and Workout Deal Principles</p><p>Workouts and restructurings are endemic to the cyclicality of the hospitality </p><p> business. Periodically, a hotel or a hotel market will go through a period in which</p><p> the net operating cash produced by the business is insufficient to meet the cash </p><p> requirements created by the sum total of operating expenses, debt service and </p><p> taxes. In any business, the approach to solving the cash shortfall problem can be </p><p> either increasing sales or decreasing expenses, but in circumstances in which there</p><p> is a market slowdown, increasing sales may not be a viable option. Thus, the </p><p> workout, a concentrated effort across numerous expense obligations to reduce </p><p> cash outlay, becomes the focus of fixing the business.</p><p>During the fall of 2008, the bottom fell out of the hospitality market, just as had </p><p> begun to happen in the economy generally. It often takes a number of months for </p><p> the retreat of business fundamentals to result in a cash default by a hotel on its </p><p> mortgage, or perhaps more problematically, an inability to meet its payroll. So </p><p> there is generally some opportunity to plan for how the various stakeholders in a </p><p> hospitality asset will deal with the shortfall. That time should not be wasted.</p><p>In creating a workout plan, there are five practical principles governing the deal </p><p> process that must be observed or the workout will fail. These are less legal issues and more issues of human behavioral management, and deal construction. </p><p>However, they are every bit as important to the success of the process as are the efficacy of the security interests and the strategic use of the bankruptcy code:</p><p>1. The stakeholders in the hotel need to be identified and each stakeholder needs </p><p> to accept the economic problem facing the hotel as his/her problem. Initially, </p><p> the lender will tell its borrower, the hotel owner, to simply pay the loan as the </p><p> market conditions are not the lender’s problem. The borrower will blame the </p><p> operator’s inefficiency for the lack of cash flow . The operator will blame the </p><p> market, and all three will try to push the problem off on each other. The fact </p><p> is that all three parties need each other to fix the problem. Otherwise, the </p><p> lender has a loan in default or worse owns the hotel. Without a workout, the </p><p> borrower loses its chance at an equity recovery and faces certain insolvency. </p><p>Without a workout, the operator loses distribution, its customers, and stature </p><p> in the eyes of its employees. Thus, the first task is to make each party </p><p> recognize what it has to lose without a workout solution, and as a result </p><p> recognize the hotel’s problems as his/her own. </p><p>2. Each stakeholder needs to make a material contribution to effecting a solution,</p><p> thereby “sharing the pain” of the economic failure. If any party believes that </p><p> it is being unfairly burdened by a proposed restructuring, the agreement will </p><p> fall apart before it is implemented. Each party needs to see that its </p><p> contribution to the solution, whether an interest forbearance by the lender, the</p><p> loss of equity interests and entity control by the owner, or reduced management fees or term security from the operator, is somewhat concomitant</p><p> in scope and relative value to the contributions made by the other parties.</p><p>3. The stakeholders need to understand that the workout is the only way to </p><p> protect their respective interests. No party will give up material value until it </p><p> concludes that doing so is the only way out of the existing dilemma. As the </p><p> workout plan solidifies, the workout practitioner must be prepared to stamp </p><p> out efforts by any party to “maintain flexibility in the process ,” as generally a </p><p> party expressing that sentiment is looking for an alternative to the workout </p><p> plan. Examine the alternatives early in the process and get the parties to </p><p> accept the solution as either the best way or the only way out of the problem. </p><p>4. The party with the plan should control the process. While the hotel owner </p><p> generally is the entity with the most to lose in a workout situation, and </p><p> therefore is naturally inclined to want to take over the process, it is also most </p><p> likely the party with the least experience in hospitality workouts. Hospitality </p><p> lenders and multi-unit operators are generally more experienced in the </p><p> process, will be able to more quickly and correctly diagnose the causes and </p><p> prescribe potential solutions for the asset, and are most likely to both </p><p> understand and be able to articulate appropriate, current deal technology for </p><p> the specific workout situation.</p><p>5. The workout plan must offer hope to each of the stakeholders. Workout plans</p><p> are only effective if the parties contributing to the solution can see that there is some hope in the relatively near term (3 to 5 years) that the contribution a </p><p> party is making now may be rewarded by future market changes in </p><p> circumstances. Whether in the form of a “kicker” for the lender, a “hope </p><p> certificate” for the owner, or an enhanced fee or equity participation for the </p><p> operator, each party must leave the deal table believing that it has preserved </p><p> some of the current value of its position and that it has a chance to “get </p><p> lucky.” </p><p>Following are some issues inherent in most hospitality workouts, and some </p><p> thoughts on how to approach the process.</p><p>II. Identify the Problem—What Cannot be Paid?</p><p>A. Debt Service Shortfalls;</p><p>1. Senior Debt;</p><p>2. Subordinated Debt;</p><p>B. Real Estate and other Non-Income Tax Issues;</p><p>C. Below the Line Operating Issues;</p><p>D. Brand Standard and other CapEx Issues;</p><p>E. Negative Operating Profit and Working Capital Shortfalls;</p><p>F. Are these systemic, long term issues or short term problems? </p><p>III Identify the Cause(s), both Internal and External.</p><p>A. Sales Efficiency and REVPAR; B. Operating Efficiency and Asset Management;</p><p>C. Debt to Equity Ratios;</p><p>D. Debt Service Step Up Issues; </p><p>E. Market Issues;</p><p>F. General Economic Issues.</p><p>IV. Who are the Stakeholders and What are Their Interests?</p><p>A. Borrower and its Constituents;</p><p>B. Senior Lender;</p><p>C. Subordinated Lender(s);</p><p>D. Local Government, Other Public Bodies, and local Corporate Entities;</p><p>E. Hotel Operator.</p><p>V. What are the Respective Leverages and Sensitivities of the Stakeholders?</p><p>A. Can the Borrower Reorganize?</p><p>B. Is the Senior Debt Recourse?</p><p>C. Does the Junior Lender have Partnership Leverage?</p><p>D. How “Bankruptcy Remote” is the Borrower really?</p><p>E. Can the Operator be Terminated by Contract?</p><p>F. What does “Performing Loan” versus “Non-Performing Loan” mean to the </p><p>Lenders?</p><p>G. Who can Bring New Capital to the Deal?</p><p>H. What does Potential Failure Mean to the local Community Constituents? I. What are the Reputational Effects of Default on the Borrower Constituents?</p><p>J. What are the Reputational Effects of Failure on the Operator and its Brand?</p><p>VI. Holding Hands Around the Campfire—Prerequisites to Fixing the Problem </p><p>A. Which Stakeholders are Motivated to Contribute to a Solution?</p><p>B. How Real and Immediate is the fear of Failure?</p><p>C. How Realistic and Immediate is the Hope for a Restructured Success?</p><p>D. Can All Stakeholders see Contributions Being Made by All Other </p><p>Stakeholders?</p><p>E. Does every Stakeholder Perceive that the Financial Problems of the Hotel are </p><p>Shared Problems?</p><p>VII. Structural Tools of the Trade</p><p>A. Operating Cash Flow Improvements at the Hotel Level;</p><p>B. Operating Expense Deferrals;</p><p>C. Operating Accrual Deferrals;</p><p>D. Debt Principal Write-Offs;</p><p>E. Debt Retranching;</p><p>F. Debt Pay or Waive;</p><p>G. Debt Pay or Accrue;</p><p>H. Debt Principal Conversion to Equity;</p><p>I. Debt Interest Rate Changes;</p><p>J. Equity Redistribution;</p><p>K. Equity New Investment Priority; L. Equity Preferred Provisions;</p><p>M. Equity Carried Interests and Other “Hope” Certificates;</p><p>N. Operator Fee Reductions;</p><p>O. Operator Fee Deferrals;</p><p>P. Operator Fee Conversion to Equity;</p><p>Q. Operator Shortfall Loans;</p><p>R. Operator Shortfall Guarantees;</p><p>S. Operator Termination on Sale/Foreclosure;</p><p>T. Government RE and/or TOT Tax Deferral;</p><p>U. Government RE and/or TOT Tax Reduction;</p><p>V. Government RE TIF/Special Tax District Contribution.</p><p>VIII. Process Principles</p><p>A. The Guy with the Plan Drives the Bus;</p><p>B. Going Broke Costs Money so Set a Workout Fund Aside;</p><p>C. Make Every Stakeholder Accept the Problem as its Own;</p><p>D. Share the Pain;</p><p>E. Create Temporary Solutions for Short/Medium Term (3-5 years) Problem;</p><p>F. Identify and Get the Easiest Stakeholders on Board First; </p><p>G. Offer Hope/Reward at the End;</p><p>H. Threaten Hostilities as a Last Resort. </p>