UK hospitality assets are usually sold by way of a sale of shares in a corporate vehicle that owns the hotel (asset sales are possible, but far less common). Hotel assets frequently are held in OpCo/PropCo structures, meaning that the holding structure is usually divided into two parts: a property company that owns all the property assets associated with the business and an operating company that uses those assets to generate revenue. The operating company will enter into franchise and management agreements and other contracts relating to the hotel business with third parties and will be responsible for all employees, pensions and other related liabilities. This structure ensures that the property assets are held in a “clean” PropCo, which can then be sold separately from the OpCo upon an exit.
OpCo/PropCo structuring also reflects the fact that the tax treatments of an operating business and a property investment are usually quite different. It may be possible to shelter capital appreciation of the property asset from tax if held in a separate PropCo held by overseas investors. The extent to which this is possible is changing, however, as the UK recently announced new rules which will remove or at least substantially restrict the ability to shelter capital appreciation in relation to property assets.
Upon a sale of corporate entity(ies), a buyer will likely acquire either both the OpCo and PropCo or just the OpCo, depending on the commercial terms of the transaction. In such circumstances, the seller will be expected to provide market standard warranties relating to the target entity(ies), including warranties relating to title/ownership of shares, debt and other borrowings, accounts and management accounts, material contracts, litigation and compliance, employment and pensions, intellectual property, data protection and insolvency. Property warranties are usually kept to minimum, for example, a basic confirmation that the PropCo is the legal and beneficial owner of the property. The seller would also be expected to give a suite of appropriate tax warranties and a tax covenant, which compensates the buyer in respect of any tax liabilities arising prior to completion of the sale. The warranties would be subject to any information provided in a disclosure letter. Warranty and indemnity insurance is becoming increasingly common, and so a seller may seek to cap its liability in respect of the warranties/tax indemnity at a nominal amount in circumstances where the buyer obtains a buyer-side warranty and indemnity policy.
Real Estate Considerations
In England and Wales property asset transactions are conducted on the principle of caveat emptor, ‘let the buyer beware’; this means that a buyer relies almost entirely on its own due diligence exercise rather than receiving warranties from the seller. Title to the land (whether freehold or leasehold) is certified by Her Majesty’s Land Registry so there is a government guarantee that the seller is the owner. The land registry title document will also set out details of restrictions and covenants burdening the land (e.g., restrictions preventing certain types of use) and rights benefitting it (e.g., rights of way over access roads). General title insurance is not available to a property owner/buyer, though specific insurance can usually be obtained for identified issues, particularly historic title restrictions (e.g., a restriction preventing the sale of alcohol on the land). The buyer will also review results of searches of the records maintained by various public registries including the relevant local authority who will confirm the planning/zoning status of the property and any enforcement action taken. It is not uncommon for land to be held on a long leasehold basis for terms of anywhere from 250 to 999 years, and a buyer will then need to conduct due diligence regarding the terms of the headlease. Estoppel certificates are not used in England and Wales, but the buyer should confirm there are no extant breaches of the headlease (though this will be achieved through pre-contract representations rather than warranties).1 Equally, it is not usual to receive a non-disturbance agreement from a third party superior landlord.
When the transaction is structured as the purchase of the PropCo (as is usually the case in hotel transactions), the seller will generally seek to replicate the asset deal position outlined above by excluding the property from the warranties (which will instead focus solely on the corporate aspects), leaving the buyer to verify ownership of the property through its own due diligence.
The acquisition of a hotel asset in England attracts stamp duty land tax (SDLT), payable on commercial assets at 5% on consideration over £250,000. Hotel assets in Wales will attract a different tax called “land transaction tax” (LTT). One key difference compared to SDLT is that if the price is more than £1 million, the part of the price that is over £1 million will attract LTT at the rate of 6%. Value-added tax (VAT) may also be payable, but in practice if the hotel is already subject to a lease, VAT is normally not chargeable.
While the benefit of capital allowances (a form of depreciation allowance) may be transferred to the buyer, certain formalities have to be observed and the ability of a buyer to inherit the seller’s allowances is not automatic. Any carried forward tax losses associated with the hotel asset cannot however be transferred and will remain with the seller.
The tax treatment of the purchase of a corporate entity is, however, quite different from the acquisition of an asset. No stamp duty should be payable on the acquisition of an entity incorporated outside the UK, while stamp duty at 0.5% of the consideration will apply on the purchase if the entity is incorporated in the UK. VAT should not apply to the purchase price, irrespective of the use or VAT status of the underlying asset. However, the tax “history” of the entity will transfer in the sense that it remains with the entity and the buyer becomes economically exposed to it as shareholder. Therefore the buyer will effectively inherit the historic capital allowances position, and carried forward losses should also transfer (although specific rules may limit the ability to utilise these). Importantly, any historic tax liabilities of the entity will transfer; it is therefore usual to seek protection on these from a seller in the form of tax warranties and a tax covenant, often backed up by warranty and indemnity insurance.
Hotel employees will usually transfer to the buyer of the hotel, irrespective of whether the transaction is structured as a share or asset sale. This is due to legislation known as TUPE, which was implemented to give effect to the EU Acquired Rights Directive. The sale of a hotel asset in most cases will be considered a business transfer under TUPE, meaning that the employment contracts for all existing hotel employees (with limited exceptions) would automatically transfer to the buyer on their existing terms by operation of law.
Unlike the U.S., few of the major hotel operators will agree to act as the employer of record for hotel employees. Hence, understanding employment and pension liabilities is an important part of a hotel transaction for any foreign investor.
Franchise Agreements / Management Agreements
If the hotel is managed by a third-party operator or operating under a third-party brand, the buyer should assess whether it has flexibility regarding the retention or termination of the operator and/or the brand upon completion of the acquisition. More often than not, there are limited options to terminate the franchise and/or management agreement as they are often structured to survive a sale event. As such, the seller needs to ensure the buyer assumes the agreements when it purchases the hotel, even if the agreements sit at the OpCo level. This does not mean that the agreements must be accepted “as is.” Due diligence may have identified areas of concern with a management agreement (less so a franchise agreement) that the buyer wishes to address. While the buyer may not be able to dislodge the operator, the buyer may be able to negotiate a change in brand within the operator’s brand portfolio. As such, side negotiations with the brand and/or operator are often a key strategic part of a hotel purchase and sale transaction.
Negotiations with a brand or an operator can be time consuming, and the due diligence process that the international brands insist on carrying out on any proposed buyer is not necessarily swift. Because transactions usually have their own timing impetus, it is important to focus on the brand and operator arrangements as early as possible and factor in an appropriate period to properly deal with those arrangements.
As always, involving advisers early in the process can remove any surprises arising from local idiosyncrasies and facilitate an efficient transaction process.
 A representation is a statement made before a contract is entered into so as to induce a party to enter into the contract. By contrast, a warranty is a term of the contract itself. Consequences for a breach of warranty differ from the consequences for misrepresentation; misrepresentation entitles the wronged party to terminate and claim damages, whilst a breach of warranty gives rise to a right to damages only.