The pandemic has brought much uncertainty to the hotel sector — Intermittent national and regional lockdowns, work from home mandates and restrictions around domestic and international travel have left hoteliers in the unenviable position of keeping the lights on but without the occupancy or footfall of pre-2020. Government measures have no doubt helped, especially the ability to furlough large sections of the workforce, but as these measures are tapered down, some hotels – particularly city centre and airport hotels which rely on business travel — will struggle. Coupled with staff shortages and the increasing cost of supplies, both of which create operational difficulties and squeezed margins, it is likely that some hotels may not survive within their existing funding/ownership structures.
This will inevitably give rise to opportunities for those with deep enough pockets, appetite and know-how to invest in distressed situations. While not a substitute for bespoke legal advice, set out below are some points to consider when acquiring a distressed hotel asset.
Whilst this publication focuses on opportunities in the UK, international and cross-border M&A in the hotel sector is also likely to pick up in the coming years. The guiding principles below are equally applicable to cross-border deals in the hotel sector, and broad experience in evaluating investment opportunities and risk across asset classes and capital structures is necessary. Parties need good global advisors who understand their business objectives and have a keen understanding of local insolvency regimes and applicable legal frameworks, regulatory approvals, bidding strategies, diligence and liability management, tax structuring and anti-trust impacts.
A share acquisition in an accelerated M&A process (i.e. a sale on a compressed timeline due to the seller’s financial distress) will mean that you inherit all liabilities attached to the underlying target company. If the target is distressed and debt and creditors have not been paid or serviced for some time, this may (i) need to be reflected in the price to be paid for the shares and (ii) necessitate careful negotiations with key suppliers/stakeholders to ensure continuity of trading once you have acquired the shares, especially in relation to change of control provisions in contracts. Due to issues which arise during the diligence process, it is not uncommon for an accelerated M&A process to culminate in a sale of the business and assets only, often conducted through an insolvency process (for example a pre-packaged administration).
If the asset is only brought to market after an insolvency process has commenced, options to acquire include an asset sale or transfer of a going concern sale, whereby the whole of the business and assets are transferred, orchestrated by an insolvency practitioner through an insolvency procedure or receiver through a receivership. If the sale is not to be a transfer of a going concern, buyers can alternatively cherry pick those parts of the business and assets that they wish to acquire. Structuring will require tax planning in any event.
Any distressed acquisition, both inside and outside of a formal insolvency process, will necessitate a buyer or investor who is comfortable in moving quickly. Timing for deal execution is often dictated by the available cash runway or milestone date imposed by the incumbent lender(s) by which the seller must dispose of the distressed asset. As such, any buyer must be able to move at pace, making and taking decisions quickly in the context of the distressed landscape. Specialist legal counsel is essential to facilitate the acquisition. Credit approval should be sought on the basis that the deal terms may often change at the last minute and provide scope for decisions to be made accordingly without necessitating further approval or sign off, to the extent possible.
Getting comfortable with the uncomfortable
The timing of a distressed investment, coupled with the lack of information that is typically provided about the asset in a distressed scenario, means that any buyer could have to get comfortable to proceed on the basis of information available. Diligence is often carried out on an accelerated timescale and limited basis. To the inexperienced, this can be uncomfortable and may limit the potential pool of buyers.
However, it is important to remember that when transacting with an insolvency practitioner, buyer due diligence is typically all you would have to fall back on. This is due to the lack of representations and warranties that insolvency practitioners provide in a sale scenario. Furthermore, administrators and liquidators contract with the exclusion of their personal liability meaning buyers have nowhere to turn if the acquisition turns out to be not what they expected. It will be for the buyer to carry out a level of diligence in the time available that is reflective of the nature of the asset and potential risks. The assistance of seasoned professional advisors who know the terrain will provide an advantage to bidders.
Further assurance provisions in insolvency sale documents are typically very limited in scope and time so buyers should think carefully about what assistance they may need post-acquisition and then seek to reflect that in the sale documentation. Furthermore, an acquisition of a distressed business or asset outside of a formal insolvency, but on an accelerated M&A basis, although more likely to contain more complete further assurance provisions, the likelihood of the seller business being around to provide such assistance in three to six months’ time is far from certain. Both these circumstances highlight the need to retain key employees who will be able to assist with any transition, or alternatively have a transitional service agreement in place with the selling entity.
Buying from an administrator or liquidator (an insolvency practitioner)
As mentioned above, the documentation for a sale by an administrator or liquidator will look very different to that provided in a solvent sale.
Officeholders do not provide representations or warranties, there is no buyer indemnity and instead a buyer will be expected to indemnify the officeholder against specific risks (for example liability under the TUPE Regulations in relation to employee liabilities).
Synthetic insurance is available on the market but it can be costly and often there is insufficient time to implement in the context of a distressed sale.
It is always prudent for an officeholder’s appointment to be verified by buyer’s counsel to ensure that they have the authority to act on behalf of the selling entity.
Practical and operational points
Sales that are structured as transfers of going concerns attract significant liabilities under the TUPE Regulations insofar as concerns employees’ rights. It is not possible to contract out.
If a business is distressed, if applicable, it is advisable to consult with the pension regulator prior to contracting to ascertain whether they are likely to intervene.
Consideration as to necessary consents required to ensure operational continuity should be given, especially in relation to premises and wedding licences. The terms of any lease under which the hotel is held should be considered for any specific provisions that may be relevant in the circumstances.
It is likely that customer deposits/prepayments will have been dissipated in the period leading up to a sale such that upon an acquisition of the business, the buyer will have to factor in the impact of this on the balance sheet and budgets.
Consideration should also be given to any retention of title claims that a supplier could rely on to take away stock and ensure the sale documentation reflects any ROT stock issues.
The existence and terms of any HMAs and non-disturbance agreements should also be considered in the context of a distressed sale. As a competitor operator of the current operator of a distressed asset, careful consideration should be given to the ability to terminate the HMA, especially any financial consequences that may mean an offer is not capable of acceptance by the office holder (who in the case of an administrator will be obliged to obtain the best possible price for the asset, or otherwise he/she may face criticism or challenge to the sale).
Simon ThomasPartnerFinancial Restructuring, European Offices