The importance of representations and warranties in hotel purchase and sale agreements
by ERIC TUCKER
The decision to purchase or sell a hotel property is not one that is taken lightly; once made, it often involves substantial negotiation between the parties as to the key business terms. However, once the business terms have been agreed upon and the deal moves to the purchase and sale agreement (PSA) stage, many principals do not spend the same time and effort negotiating the representations (or “reps”) and warranties contained in the PSA, and they do so at their own peril.
Why is overlooking the representations and warranties so risky? Currently, almost every hotel sale is made on an “as is, where is” basis, and most PSAs will contain some version of a disclaimer and release that effectively provides that the seller is only liable for a breach of the express reps and warranties contained in the PSA. So, in the event of a dispute between the buyer and seller after closing, the reps and warranties contained in the PSA will become the universe in which the dispute is decided. Through that prism, the reps and warranties in the PSA are actually one of the most important set of provisions as they dictate the rights and obligations of the parties after the transaction closes.
Buyers should focus on operational representations regarding the hotel like: (1) the state of repair of the guest rooms and FF&E, (2) all current repairs to the hotel were fully paid, (3) all financial documentation provided by the seller during due diligence is true and correct, and (4) Seller compliance with all applicable laws and regulations in the operation of the hotel. Conversely, a seller should focus on limiting the scope of the reps and warranties as much as possible. Consider making a statement that the seller has not received written legal violation notices as opposed to providing a blanket representation that the seller has complied with applicable laws. Sellers also typically seek to insert knowledge qualifiers as a means of mitigating their liability for certain representations, meaning sellers only represent what is actually known, and responsibility for that knowledge is attributed to a single named individual in the PSA. A properly negotiated PSA will reflect a compromise between these two competing perspectives on the scope of the reps and warranties.
PROPER PERSPECTIVES
Understanding that these competing perspectives exist is very important for a prospective buyer or seller of a hotel property because only one party will control the initial draft of the PSA. If you are the party receiving the draft PSA, care should be taken to closely review the reps and warranties to ensure they are even-handed and represent a fair allocation of risk between the parties. Hotel Sellers should also fully review the reps and warranties made in the PSA with their counsel to be sure that there are no exceptions to a given representation that your counsel should expressly include in the PSA, e.g. a known environmental condition.
The other important component with regards to reps and warranties in a hotel PSA is the period of time the reps and warranties survive closing. A seller’s preference will be for the reps and warranties to expire on the closing date, while a buyer’s preference is for the reps and warranties to survive until the expiration of any applicable statute of limitations. A typical hotel PSA compromises on the survival of the reps and warranties beyond closing for a limited and well-defined time period. From the buyer’s perspective, the survival period needs to be long enough for the buyer to operate the property to determine if any of the reps and warranties were inaccurate. Conversely, the seller will prefer as short a survival period as possible after closing to limit the amount of time its exposed to liability to the buyer for representation and warranty claims under the PSA. Therefore, the survival period issue should not be overlooked, as ignoring this component could effectively undermine a party’s efforts to negotiate mutually acceptable reps and warranties if they do not survive closing (if you are the buyer) or survive closing for an unreasonably long period of time (if you are the seller).
POINTS OF NOTE
The last elements in the hotel PSA related to reps and warranties that the parties should be prepared to address are a negotiated minimum claim threshold and a maximum cap on the seller’s liability for breaches of the reps and warranties. This type of provision is now routinely required by sellers when their reps and warranties survive the closing. The threshold is an aggregated dollar amount the buyer’s claims must exceed before they can advance a claim against the seller; think of this analogous to a deductible in an insurance policy. The cap is a straightforward limit on the aggregate amount of all possible claims against the seller for breaches of the representations and warranties in the PSA. While these provisions are clearly not preferred by buyers, they have become relatively common in recent years, and including such a provision provides a quid pro quo for the seller to agree to a survival period for the reps and warranties. The exact amounts for both the threshold and the cap need to be negotiated on a case by case basis, taking into account: (1) the total purchase price for the hotel, (2) the scope of the final reps and warranties (and the seller’s corresponding exposure) negotiated by the parties, and (3) any history of issues with the hotel business or the underlying real estate.
In summary, principals buying or selling hotel properties should focus as much time and effort on finalizing the representation and warranty provisions of the PSA as they do on negotiating the primary business terms. In the event of a post-closing dispute between the parties the reps and warranties will be the key provisions in the PSA that influence the outcome. Ultimately, entering into a PSA after ignoring the representations and warranties is a major risk.
Eric Tucker has more than 15 years’ experience representing hotel developers and operators in all types of hospitality transactions. He can be reached at [email protected] and www.offitkurman.com/attorney/eric-tucker.
