A crisis can arise at any time—day or night, holidays or weekends—especially in a financially troubled hotel. Often, if the problem is not dealt with immediately—perhaps the long unpaid laundry vendor decides it will not deliver the weekend’s sheets and towels unless it is paid in cash—the viability of the hotel can come into immediate danger.
Unlike other commercial properties such as an office building, which typically has long-term leases with predictable cash flows and limited services, a hotel has hundreds of nightly “occupancy licenses,” with widely fluctuating cash flows depending on the time of year, weather, strikes, overseas financial crises, a sudden drop in tourism, present competition, and other unpredictable events. And, unlike an office building, a hotel’s revenue, and thus its value, can be instantly and capriciously affected by adverse comments about the hotel in popular social media such as TripAdvisor and Twitter.
Running a hotel is extremely labor intensive, requiring far more personnel than a conventional commercial property to service the 24-hour needs of the hotel’s constantly changing daily guests. These guests require intensive services to keep them content, e.g., room service, maid/cleaning (soap, sheets, towels), restaurants/bars, health clubs, front desk services, etc. Thus, operating a hotel in foreclosure is a far more complex task than operating an ordinary commercial property in foreclosure.
Practitioners who are receivers and counsel for receivers encounter a number of issues—many of them emergencies threatening the operations—each of which could be the subject of a separate article. Some key issues are discussed below.
Who and What Is a Receiver?
Receivers are court-appointed fiduciaries who act on behalf of the court. They are, in effect, an “arm of the court,” and take possession of property, e.g., real estate, which is the subject of litigation, and usually in foreclosure. Receivers operate the property on behalf of the appointing judge.1 The receiver’s task is to “preserve the status quo” of the property as best as he can during the litigation.2 Otherwise, the goal of the litigation could be mooted if the property were to diminish in value by the end of the lawsuit.
A defaulting mortgagor likely is removing as much money from the property as is possible, has not paid its real estate taxes and vendors, and has not maintained the property. Allowing such a mortgagor to remain in control of the property during the course of litigation will surely result in a decline in the value of the property. Thus, the court appoints a receiver with the hopes of stopping this decline during the foreclosure.
Typically, a receiver is appointed upon the application of the plaintiff, ex parte, if the mortgage so permits, or by formal motion of the plaintiff (e.g., lender, bank). The order appointing the receiver provides the receiver with a “road map” prescribing his or her authority to operate.3 If the receiver finds that he or she must perform an act that is not provided for in the order, then the receiver should seek permission of the court to expand the scope of his or her duties. No matter how well intentioned, a receiver acting for the benefit of the property acts at his or her peril unless such authority for his or her acts is provided for by the order or subsequent amendment to it.
Obtaining additional authority to act from a court protects the receiver from criticism and assists the appointing court, as the expanded order enables the court to better monitor and understand what is occurring in the receivership. Oftentimes, a receiver will obtain permission from the court to hire his own counsel. It is important to note that even though a single attorney is appointed as “Counsel to the Receiver,” the receiver is generally permitted to utilize the expertise of all of the attorneys at his counsel’s law firm. Thus, when a receiver manages a multimillion-dollar asset such as a hotel, it is generally a good idea if his appointed counsel is from a full-service law firm with the capacity to handle employment, labor and union issues, complex litigation, insurance law, data breach issues and the like.
As previously stated, the receiver’s primary task is to preserve the “status quo.” But, what does preserving the “status quo” mean in the context of an open and operating hotel receivership?
A receiver must use commercially reasonable efforts to prevent a property under his or her possession from suffering harm or waste during the receivership.4 Does the receiver preserve the status quo by doing nothing? No. On the other hand, should a receiver improve the property so much that it morphs into something else, for example, turning a three-star hotel into a five-star facility? No.
As a practical matter, a receiver protects the property from “harm or waste” not only by preventing any further deterioration, but also by curing existing problems and allowing the property to maintain its value as loan collateral. This, of course, must be done within the confines of the cash available.
Managing a troubled business can be a challenge for anyone, but the challenges facing a hotel receiver are exponentially greater because of a hotel’s complexity. The following are just a few of the issues a hotel receiver will encounter.
Management Company. Upon assuming control, a hotel receiver must promptly determine if the current management is properly operating the hotel. An independent third-party management company may be doing a competent job, but may be hampered by lack of financial support. An owner-operator most likely is not doing the proper job, and should be replaced.
Determining whether current management is competent sometimes requires more than an analysis of the books and records and visits to the property. In such event, the receiver should request the court to appoint an accountant and possibly a hotel consultant, to aid the receiver in determining whether existing management should be replaced. If existing management has been stealing funds, the receiver may decide to seek permission of the court to utilize his court-appointed counsel to initiate “claw back” litigation to recoup the stolen funds.
Finding replacement management is not an easy task. The receiver, with the assistance of the hotel consultant, will interview prospective management companies and present to the court several qualified finalists. The court, often upon recommendation of the receiver, will choose the hotel consultant. A management contract between the receiver and new manager will need to be negotiated and approved by the court. Reflecting the complexity of operating a hotel, the contract will likewise be complex and nuanced and will need to address the specific issues involving the property and the operations of the hotel.
The transition from the old management to new management can be daunting. Operating systems can be neglected, or worse, completely non-functional. Non-unionized employees, especially retained managers, will be fearful and suspicious and will need to be calmed. The receiver and new management must be experienced, sophisticated and capable of tackling these problems to ensure a smooth transition.
Utilities and Vendors. Keeping the lights on at the property sometimes literally means making sure that utility companies do not cut off electric service, fuel or necessary supplies for non-payment. The receiver must quickly ascertain what utilities, service providers and vendors are critical to the operations of the property, and which have not been paid. The receiver will need to make immediate arrangements to pay the utility companies and critical vendors, even if on an installment basis. A hotel cannot run without electricity, heat, air conditioning, telephone/Internet service, housekeeping, staff, clean linens, etc., and many vendors will likely not have been paid for months. At the beginning, many vendors will demand cash (or at least a check) upon delivery for products and services needed during the course of the receivership. This can impinge on already anemic cash flows. New management must strive to restore normal payment terms.
Data Breach Issues. Often, distressed hotels do not invest in their data systems. Any business that receives credit/debit card and other confidential information could be liable for damages from an unauthorized release of this information. The heavy use of credit and debit card transactions in the hospitality industry makes it a primary target for cyber criminals. Moreover, employees may inadvertently allow access to personal customer information. However it occurs, a breach of personal information can create enormous liabilities, and damage reputations.
A receiver and the management company must upgrade inadequate data systems and develop information security policies to protect against these liabilities. Oftentimes, a receiver who is an experienced litigator or whose counsel has experience in defending against data breach lawsuits is best suited to avoid any such lawsuits in the first place by being proactive in enhancing data security.
Insurance Issues. It is critical that a receiver ensure that necessary coverage is in place prior to qualifying as receiver. Otherwise the receiver could be exposed to personal liability for any insurable event that occurs during the receivership. Furthermore, a serious uninsured event such as a fire could threaten the viability of the property. A hotel needs commercial general liability (CGL) insurance and commercial property insurance, employment practices insurance, Workers’ Compensation insurance, and disability insurance policies for employees.
If the hotel serves liquor, the CGL policy should include a rider for liquor liability coverage. Other necessary policies include crime policies (both for employee theft and theft from guest rooms by third parties) and cyber insurance for data breaches. It is imperative that the receiver assess the types and amounts of insurance currently in place to safeguard against any gaps.
Employee Issues. An immediate issue is who is the employer of the property’s work force. It is typical that a management company hires the old staff as its own employees. To the extent current employees become the employees of the new management company, the receiver has to ensure that the changes in employment do not trigger any liability to the owners, such as termination payments.
The receiver must oversee all employee discipline and termination issues, assuming the appointing order even permits him to terminate employees. Finally, the receiver needs to quickly grasp ongoing employee legal proceedings initiated by disgruntled or terminated employees, whether in court or before an administrative agency such as the Equal Employment Opportunity Commission (EEOC). Thus, it is imperative that the receiver or his counsel be well versed in all of the nuances of employment and labor law.
Union Issues. Employee issues become more complicated when dealing with unionized employees. The receiver must obtain copies of all relevant collective bargaining agreements, including any side agreements that modify the collective bargaining agreement. The receiver also must become familiar with union work practices at the property. Maintaining the status quo will be nearly impossible if there is labor unrest or a strike.
Maintenance Issues. Since the condition of the physical plant often impacts the profitability of the property, the receiver must keep the property in good condition. While the receiver cannot undertake a wholesale renovation of the property, the receiver is charged with the responsibility of keeping the property in good repair and in conformance with all local building and health codes. Routine maintenance issues such as upkeep of the elevators, heating, ventilation and air-conditioning systems and the general upkeep of the building cannot be ignored.
Tax Audits. A hotel undoubtedly will have to collect and pay state and city sales and occupancy taxes. The taxing authorities conduct regular, as well as random, tax audits, and some commentators have observed that when municipalities are fiscally strapped, the taxing authorities tend to be even more aggressive in conducting tax audits. Defending against a sales/occupancy tax audit is a specialized area, and the receiver would be well served by seeking court permission to hire a specialist in this area. It must be noted that the receiver could be held personally liable for unpaid sales and employee withholding taxes that accrue during his tenure.5
Liquor License Issues. Hotel receivers must deal with the State Liquor Authority (SLA), and must be generally cognizant of liquor license requirements and applicable regulations. In New York, a hotel must have a restaurant to have a full liquor license.6 Moreover, the receiver must make sure that his name is added to the liquor license after becoming receiver as he is the legal operator. Liquor law is a highly specialized area and there are only a handful of firms that appear before the SLA. A receiver should seek permission from the court to engage Liquor Law counsel to advise on these issues.
Tax Certiorari. The drop in market value of many properties due to the recession caused them to be “under water” with their lenders. This may be a contributing factor as to why a property is in foreclosure and in need of a receiver. Often, there are pending tax certiorari proceedings being handled by specialized counsel. It would behoove the receiver to review these proceedings and seek permission from the court to engage or continue the services of a tax certiorari firm to seek reduction of the valuation of the property to achieve commensurate reductions in real estate taxes.
Neal Fellenbaum is a commercial litigation partner at Zegen & Fellenbaum. Andre K. Cizmarik , a commercial litigator, is counsel at Edwards Wildman Palmer. Fellenbaum served recently as receiver for two Midtown Manhattan hotels, while Cizmarik was appointed by the Supreme Court to act as legal counsel to him in that capacity.
1. See Matter of Kane, 75 N.Y.2d 511, 515, 1007, 554 N.Y.S.2d 457, 459 (N.Y. 1990).
2. See Friedman v. Ragin, 228 A.D.2d 642, 645 N.Y.S.2d 56 (2d Dept. 1996).
3. See Home Savings Bank v. 137 Duane Street Associates, 197 A.D.2d 368, 602 N.Y.S.2d 136 (1st Dept. 1993).
4. See Bynoe v. Riverside Church in City of New York, 13 Misc.3d 628, 630, 823 N.Y.S.2d 853 (Sup. Ct. N.Y. County 2006).
5. McKinney’s Tax Law §§1131, 1133.
6. McKinney’s Alcohol Beverage Control Law §64(5).