Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Hospitality & Tourism, May 2008
2007 was a banner year for hotel transactions in Canada, with record sales and values. Blakes was involved in three of the biggest, including Legacy's C$2.5-billion sale to Cadim, Westmont and InnVest; bcIMC's C$1.2-billion purchase of CHIP; and as Alberta counsel on Holloway's C$215-million purchase of 10 properties from Pomeroy. With concerns over the global economy and tighter credit conditions, 2008 may not keep up that pace, but the industry remains solid and transactions will continue.
Hotel transactions involve a transfer of real property, as well as an operating business. The process can be quite different depending on the parties involved, their motivations and their negotiating styles. The parties may or may not be represented by advisers, be they hotel brokers or investment bankers. The transaction may involve a single asset or a portfolio of properties. Hotels may be at different positions on the chain scale, ranging from economy through upscale to luxury. They may be newly built, renovated, historic or a combination of all three. Third parties such as lenders, franchisors, management companies, lessors and tenants may be involved. All of which goes to say that while the itinerary is generally the same, the journey can be a unique experience. However, there are a number of legal issues to be considered, whatever the circumstances.
Confidentiality and Exclusivity
A confidentiality agreement will normally be entered into at the outset of a transaction. Typically, vendors will be prepared to make a limited amount of information available to potential purchasers to stimulate interest in the properties, but will not be prepared to release detailed operating and financial information without the protection of a confidentiality agreement. The purpose of the agreement is, of course, to ensure that the information which is disclosed is kept confidential and is only used for the purpose of the transaction. Normally, these agreements can be settled without much difficulty. Nonetheless, negotiations do occur over the scope of the information to be protected, the duration of the protection, the permissibility of disclosure to persons within the purchaser's organization and to consultants, lenders and partners, restrictions on the solicitation of employees of the vendor, the retention of archival copies and other matters.
An important question in the early stages of a transaction is whether other potential purchasers will continue to be involved, or whether a prospective purchaser will be dealt with by the seller on an exclusive basis. In some cases, the process may move to a two-party negotiation quite quickly. In others, the transaction may continue as a multi-party auction until well along in the process. Whatever the case, at some point, the purchaser will want to request exclusivity during the negotiations. The vendor, on the other hand, will be concerned that any such provision not shut out other potentially interested persons for too long.
A key aspect of the process is the due diligence phase. A well-prepared vendor will want to make readily avail-able to purchasers the information and documents that they will need to review. This will include information relating to ownership structure, property tenure, debt financing, operational matters, financial performance, employees, structural and environmental conditions, contracts, liabilities, retail leases and taxation. Disclosure may take the form of an information package, a documents room or an electronic data site. Purchasers will want to review summary information, operational and financial analysis, source documents and copies of relevant agreements.
Various aspects of due diligence may take on greater or lesser significance, depending on the identity of the purchaser, the nature of the assets and other factors. In some cases, the purchaser's plans for the property may be such that zoning is of particular importance. In others, rights as regards adjoining properties may be especially significant. Parking arrangements can be crucial. Existing mortgages and the ability to assume or discharge them will be important, along with the related cost implications. Similarly, existing franchise and management agreements will be of concern, in light of the purchaser's preferences regarding continuation or termination. Trade-mark ownership as between the hotel and the franchisor can be an issue. If the hotel is unionized, the collective agreement will be important, as will employment agreements with executive staff.
Letter of Intent
Once the parties have reached a common understanding on price, they may want to sign a letter of intent to deal with certain key areas before negotiating a definitive agreement. The letter of intent will normally set out the identities of the vendor and purchaser, which can be significant in terms of the financial substance of the entity undertaking the purchase obligation, and which may raise a question of whether a guarantee would be appropriate. On the vendor side, if for example the entity is a partnership, it will be important to make sure that the partners are appropriately represented.
The letter of intent will identify the assets involved, which may include freehold or leasehold interests in real property, as well as moveable and other property, including intangible assets. The letter could also set out how mortgage and franchise agreements are to be dealt with, as well as whether any third party consents under other contracts are required. It could address the extent to which representations and warranties are contemplated. The letter could also deal with whether employees are to be transferred or terminated, and which party is responsible for termination costs. It may provide for deposits payable immediately or on signing the definitive agreement, which deposits may be refundable or subject to retention in certain circumstances. The letter would normally be stated to be non-binding except in certain selected respects.
A key issue will be the extent to which further due diligence by the purchaser is a condition of the transaction. The letter may provide for a due diligence period during which the purchaser can continue its examination. In some cases, this might continue after the signing of the definitive agreement. There may also be a question of approval by a board of directors. Clearly, the presence of a due diligence or board approval condition means that closing will be less certain until it is satisfied or waived.
Whether or not the parties sign a letter of intent, they will proceed to negotiate a definitive agreement of purchase and sale. The definitive agreement will deal with the particulars of the transaction, including representations and warranties, covenants, conditions precedent, closing deliveries, public announcements and other matters. Often, the purchase will be stated to be on an "as-is where-is" basis, given the purchaser's opportunity for due diligence. This will specifically limit the purchaser to the express representations and warranties in the agreement, which generally support the disclosures made by the vendor.
Covenants will include provisions relating to the conduct of operations until closing. The purchaser will be concerned about maintaining inventories of operating supplies and equipment, as well as group and convention bookings and room rate agreements. Conditions may include third party consents or releases. Very large portfolio transactions may be subject to Competition Act pre-notification, or Investment Canada review where the purchaser is a non-Canadian.
Specific provisions will often be included to prorate for room revenues, guest ledgers, booking deposits, food and beverage revenue, vending machines and unopened inventory. Particular provisions could also address custody of guest baggage and safe deposit boxes. Termination provisions may deal with the vendor's right to retain a deposit as liquidated damages if the purchaser defaults. Limitation provisions may limit vendor's liability to the purchaser for breach of representation and warranty to some percentage of the purchase price.
Once the definitive agreement is signed, the parties will work to satisfy the closing conditions. On the night prior to closing, inventory will be counted and the statement of adjustments will be prepared. Then the formal closing will occur and the purchaser will take over operations. Post-closing adjustments will be made within some agreed period of time afterwards. Hopefully, warranty disputes will not arise, and the vendor can proceed to reinvest the sale proceeds and the purchaser can look forward to operating the hotel successfully.
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.