Negotiating Comfort Letters in Hotel Loans

Praccal Guidance

Negotiating Comfort Letters

in Hotel Loans

A Practical Guidance

Practice Note by Donald A. Shindler, Clark Hill PLC

Donald A. Shindler

Clark Hill PLC

This practice note discusses what lender comfort letters

(LCLs) are, their role and applicability in hotel financing

transactions, how LCLs work in practice, and the

importance of various terms and provisions commonly

found in LCLs.

For guidance on hotel purchase and sale transactions, see

Hotel Purchase and Sale Agreements, Letter of Intent for

Hotel Acquisitions, Hotel Acquisition Due Diligence Request

List, Hotel Financing Diligence and Closing Checklist, Hotel

Purchase and Sale Closing Checklist, and Hotel Franchise

Agreements. For a form of comfort letter, see Hotel

Franchisor Comfort Letter. For a form of hotel purchase and

sale agreement, see Purchase and Sale Agreement (Hotel).

What is an LCL?

Given the current adverse economic impact of the

COVID-19 global pandemic on the hospitality industry

worldwide, hoteliers, managers, owners and operators,

franchisors, and lenders are reviewing their respective

financial exposures. One issue requiring careful

consideration by all interested parties is the potential

imposition and handling of liability by each. Lenders,

specifically, often possessing less knowledge about the

nuts and bolts of hotel operations, are reviewing both

their documentation for existing loans and are considering

concerns brought to the fore by the current hotel

performance downturn.

Hotel loan transactions can be more complicated than

financing transactions on other types of commercial real

estate, such as, for example, a loan secured by a mortgage

on industrial property occupied by a single, creditworthy

tenant under a triple-net lease. Just as operating a hotel

(an overnight, often labor-intensive business cloaked in an

expensive, fixed asset requiring constant refurbishment,

maintenance, upkeep, and adherence to promulgated

operating and appearance standards and protocols) is

not for the unknowing, neither is making and managing

a hotel loan successfully. In addition to the typical loan

documentation most lawyers would recognize, hotel loans

require a number of additional documents and terms in

order to define the roles, duties, and obligations of the

relevant parties, including the “waterfall” flow of funds

and allocations of potential liabilities. Understanding terms

such as RevPAR (revenue per available room), ADR (average

daily rate), OCC (occupancy rate), radius restrictions, brand

standards, and a host of others common to the industry is

necessary; understanding the working interaction of hotel

transaction documents such as Franchise Agreements,

MTAs (Master Technology Agreements), TSAs (Technical

Services Agreements) and, to the point of this practice

note, LCLs constitute fundamental elements of a hotel

transaction and the ability of the parties to negotiate and

close a hotel financing transaction.

So, what are LCLs and how do they fit into a hotel loan?

Simply put, LCLs are tri-party agreements among hotel

owners, lenders, and franchisors providing the brand

nameplate or flag for the property (as well as a number of

additional deemed benefits such as reservation systems,

loyalty programs, operational standards and protocols, and

rights to use the brand’s intellectual property). They are

structured to provide the lender with certain comforts,

including the right to maintain in place:

• The franchise agreement

• Brand identification

• Current operation and procedures

• Its security interest in the real property and the results of

the business operations thereon

Since franchise agreements are typically non-assignable and

franchisees must be accepted by a franchisor, the hotel

brand or franchisor has leverage over a lender seeking to

foreclose and assert its rights over the collateral in the case

of a default by a borrower/hotel owner. From a franchisor’s

point of view, it prefers not to have a loss of an outpost

of its chain of franchised and branded hotels nor suffer

a loss of a payment stream of franchise fees. To facilitate

continuation of its brand at the location in question and

viability of security for the underlying loan transaction,

both franchisors and lenders seek the contractual rights

and privileges encompassed in LCLs. The third party to the

LCL, the owner, usually has the least amount of negotiating

leverage and is a signatory to provide for various covenants

and representations to the other two parties to tie together

its separate documentation with each, such as the franchise

documentation with the brand and the loan package with

the lender.

Briefly, a LCL customarily allows a lender to foreclose

or accept a deed in lieu of foreclosure (or otherwise take

over a mortgaged hotel property which serves as collateral

for the loan) in the event of a default under the loan and

continue its operations under the franchise agreement

between a defaulting owner/franchisee and the franchisor.

A franchisor wants the lender or its buyer in a foreclosure

auction or sheriff’s sale to accept the franchise agreement

and cure any outstanding defaults (usually, other than

nonpayment of past-due franchise fees) as well as continue

to comply with the terms of the franchise agreement.

Without a LCL in place, neither a lender nor its buyer have

any rights to continuation of the franchise agreement,

effectively undercutting the ability to operate under it and

denying access to the value of the brand provided by the

franchise agreement. Even with a LCL in place, the lender

or buyer must ensure that management of the hotel

location is or remains acceptable to the franchisor.

Each major hotel brand has its own LCL form and

procedures governing terms and provisions as well as

acceptable negotiated revisions to its form. However, most

are very similar as to the primary content of its LCL and

it is important that the lender and its counsel understand

the terms and how they are applied. The general terms and

provisions found in LCLs are summarized below.

Parties

The hotel franchisor produces the LCL on its letterhead

and it is addressed to the lender with the owner/franchisee

joining the lender as signatories in acceptance of the terms

of the LCL. The introductory section will reference the

franchise agreement, identify the property, and establish

the purpose of the LCL as connected to the grant of the

proposed loan. If lender is the lead of an affiliated group

or a consortium of two or more lender entities, that fact

situation may be raised here but should be addressed later

specifically in the body of the letter.

Franchisee Default

This provision states the operative elements of the LCL

and grants the lender the right to require the franchisee to

provide notice of any franchise default and the opportunity,

but not the obligation, to cure same if the franchisee fails

to do so. The LCL grants the lender cure periods. A lender

should seek 10 to 30 days from notice (preferably receipt

of notice) for monetary defaults, at least 30 days for non-

monetary defaults with the right to extend 90 to 180 days

if the default is not susceptible of cure in the shorter time

frame but the lender has commenced and is (diligently)

pursuing cure.

Usually, the franchisor indicates it can extend time

frames as it determines in its sole discretion, without

triggering further default issues under the franchise

agreement, allowing the parties more time to attempt

negotiated resolutions prior to any acquisition by the

lender which might be deemed a sale, thus imposing

potentially other adverse impacts upon the franchise and

the lender. Additionally, this section should also contain

provisions regarding defaulted payments, franchise transfer

arrangements, and fees if the lender elects, within a given

time frame (30 to 45 to 60 days), to accept and continue

the franchise agreement. Alternatively, it will establish

the short window for the lender to elect to terminate

the franchise agreement without it being subjected to

the franchise termination fees. In such event, the owner

remains liable therefor. If the lender elects to terminate the

franchise agreement, this section of the LCL will reiterate

the strict duties and obligations of the parties, and likely

establish a short time frame to accomplish the same,

which will include de-identification of the property from

the franchise. If the lender’s acquisition of the property is

delayed due to the pendency of foreclosure proceedings,

then the franchisor will grant the lender additional time

provided the operation of the property is continued in

accordance with the franchise agreement and, at the very

least, non-monetary defaults are brought current. Following

acquisition of title to the property by the lender or its buyer

and acceptance regarding ongoing management of the hotel

by the franchisor, a new franchise agreement would then

be executed.

Non-Assignability

This provision clearly declares that the lender has no rights

to assign, transfer, sell or convey the LCL or any rights

thereunder but will often address the situation of limited

rights to transfer to related, creditworthy affiliates of the

lender and other similar entities or co-lenders provided

that sufficient information regarding the specific parties

and interests involved is given to the franchisor within a

strict time frame depending on the specific situation. For

example, if the transfer of the loan or allocation of portions

thereof is planned to occur post-closing, then the LCL may

grant a right to do so and assign the ongoing benefits of

the LCL to a designated party or party within a defined

period of time, often within six months of the loan closing

and issuance of the LCL. Additionally, it may provide for

such an assignment upon a subsequent acquisition of the

lender by a qualifying financial entity.

Franchisee Acknowledgment

A franchisee or licensee under the franchise agreement

(the borrower under the loan) acknowledges that the LCL

is provided at its request to effectuate completion and

funding of the desired loan and in consideration provides

a broad release of the lender and the franchisor from

any and all actions, claims, etc. arising from the lender’s

exercise of any rights granted by the LCL. It also grants

he franchisor the ability to rely on any notices provided by

the lender under the LCL in the exercise of any rights held

by the lender without reference to the owner which is the

franchisee/borrower. This protects both the lender and the

franchisor under the LCL vis-à-vis the owner.

Notice Provisions

This provision provides that the lender agrees to give the

franchisor prompt notice of any exercise of the lender’s

rights to institute foreclosure or receivership actions against

the owner, accepting a deed in lieu of foreclosure or

otherwise taking ownership. The timing of this notification

is frequently subject to negotiation since lenders do

not always track these timing requirements accurately.

Establishing a reasonable time frame for delivery of

such a notice is negotiated providing that the lender will

deliver such notice within 5 to 10 business days of any

of the foregoing actions. This should be acceptable and is

advisable to avoid the risk of triggering a default in timing

due to the delivery not occurring simultaneously with taking

any such actions. Requiring a lender to deliver such notices

prior to the action to be taken is not recommended from a

lender’s perspective. Other elements of notice provisions in

LCLs include establishing:

• Notice addresses and addressees for the parties

• Timing and effectiveness of notices of changes

• Manner of provision of notices

• Requirements for notices regarding material modifications

or satisfaction, cancellation, sale, or assignment of the

loan

Confidentiality

LCLs contain confidential information and provisions limiting

disclosure privileges to need-to-know parties are typical.

Violations can lead to termination of the LCL and loss of

the rights and protections granted. Generally, little leeway

exists regarding negotiation of confidentiality provisions.

Governing Law

Unlike loan documents, wherein governing law except for

location of real property pledged to a lender is determined

and selected by the lender, in LCLs, franchisors establish

the governing jurisdiction and, to the extent permitted by

applicable law, require enforcement of all rights, remedies,

duties, and obligations in and under the franchisor’s

selected jurisdiction. These provisions typically include

waivers regarding service, personal jurisdiction, forum non

conveniens claims, and jury trials. The jurisdiction chosen

by the franchisor usually is one that has adopted legislation

deemed favorable to a franchisor’s perspective and needs.

Miscellaneous

LCLs generally end with a variety of miscellaneous

provisions dealing with some or all of the following:

• Mutuality of negotiation

• Legal consultation by the parties

• Call for strict adherence to terms and provisions

• Provide for execution in electronic form

• Address multiple counterparts and PDF copies and

validity thereof

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Donald A. Shindler, Senior Counsel, Clark Hill PLC

Donald A. Shindler is Senior Counsel in the Real Estate Practice Group and Co-Leader of the Food, Beverage & Hospitality Industry Team at

Clark Hill. He also is a member of Clark Hill’s General Counsel Office and serves as General Counsel for the firm’s Chicago office.

In addition to providing strategic counseling and advice to clients on matters including business formation, corporate governance, ownership

succession issues, business planning, and the preparation and negotiation of a variety of contracts and transactional documents, Don

counsels hospitality clients (hotels, resorts, restaurants, spas, and food service companies) in corporate, real estate, and financing

transactions, focusing on acquisitions and sales, credit facilities, restructuring and workouts, leasing, construction, and energy-related

matters. He has represented numerous institutional corporate and entrepreneurial entities in connection with hospitality, corporate, real

estate, financing, and energy-related transactions; development, leasing, construction, and buildout; structuring and management of entities;

and arbitration and mediation of real estate-related disputes.

Don has spoken extensively before Bar and industry groups in connection with hospitality and real estate matters and has written articles

on the subject.

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• Establish deadlines for complete execution and delivery

by all parties upon penalty of expiration or termination of

the LCL –and–

• Provide for severability

Each party usually has some favored clauses it wishes

to include and, unless any party becomes too prolix, can

negotiate for those to be added. Further, note that the

franchisor often insists on receipt of executed, scanned

copies of the negotiated LCL by email before it will release

its signed counterpart LCL. That must be considered in

coordinating timing of a loan closing.

It is worth noting that LCLs are distinguishable from

Subordination, Non-Disturbance and Attornment

Agreements (SNDAs). SNDAs in hotel transactions are tri-

party agreements among the owner, lender, and a tenant

or, in the case of a brand management company, the hotel

manager. SNDAs with a tenant do not provide any material

rights regarding a brand to a lender although SNDAs, if

crafted well, can provide a comfort to a lender from the

brand managing the property similar to that provided

by LCLs (e.g., the brand manager will remain in place

on the condition that the lender undertake the owner’s

obligations under the brand management agreement). For

guidance on SNDAs generally, see Subordination, Non-

disturbance, and Attornment Agreements in an Acquisition

Loan and Provisions in a Subordination, Non-Disturbance,

and Attornment Agreement. For a form of SNDA,

see Subordination, Non-Disturbance, and Attornment

Agreement (Landlord/Lender).

Obviously, hotel loans and their documentation and loan

closing as well as management and enforcement include

much more than simply obtaining a useful LCL. However,

without an effective LCL in place as part of the loan

package, serious gaps would exist in the collateral security

desired by and underwritten by a lender. Understanding

the components of LCLs and negotiating a reliable and

workable LCL thus is critical to a lender underwriting and

funding a loan on a franchised hotel property.

This publication is intended for general education and

informational purposes only,and should not be regarded as

either legal advice or a legal opinion. You should not act upon

or use this publication or any of its contents for any specific

situation. Recipients are cautioned to obtain legal advice from

their legal counsel with respect to any decision or course of

action contemplated in a specific situation. Clark Hill PLC and

its attorneys provide legal advice only after establishing an

attorney-client relationship through a written attorney-client

engagement agreement. This publication does not establish an

attorney-client relationship with any recipient.