Buying a Hotel? Don’t Let the Seller’s Liabilities Come Back to Haunt YouJune 2009
When you purchase a hotel, you are acquiring more than just a piece of real estate. You also become the owner of an ongoing hotel business. A buyer can protect himself against claims concerning the real estate by purchasing title insurance. However, title insurance does not protect the owner against claims arising from the operation of the seller’s business on the hotel property prior to the sale. This article discusses the types of seller liabilities that should concern a buyer when negotiating the purchase of a hotel business, and suggests ways in which the buyer’s exposure can be limited in an agreement of sale between the parties.
A buyer should insist that the seller disclose all liabilities concerning operation of the hotel, even if the buyer does not intend to assume these liabilities. The agreement of sale between the seller and buyer should contain representations and warranties by the seller as to:
- contracts which affect the property such as equipment leases, contracts with maintenance personnel and similar agreements
- taxes which the seller is subject to and which relate to the operation of the property, such as income taxes, payroll taxes and sales taxes
- wages payable to employees
- amounts due to suppliers of goods and services, such as food, toiletries and linens
- obligations tht the seller has to customers, such as customers who have booked banquets, parties and the use of hotel meeting facilities
Disclosure is the first step towards obtaining an accurate picture of what the seller owes and what the buyer might be responsible for upon the purchase of the hotel.
Most hoteliers routinely enter into contracts with vendors for everything from furniture, locks and phone rentals, to lawn and landscaping maintenance. A prospective hotel buyer should analyze these contracts to determine whether they are acceptable. If the buyer wants to assume the contract, then he or she should review the contract to make sure it can be assigned without the vendor’s approval. If the approval of the vendor is required for a valid assignment of the contract, the seller should be obligated in the agreement of sale to obtain that approval prior to closing. If the buyer does not want to assume a contract, then the buyer should determine whether the contract can be terminated by the seller prior to closing. Contracts for a specific term that cannot be ended before the term expires will have to be addressed in the agreement of sale. The buyer may require that the seller buy out the contract or simply agree to remain responsible for payments under the contract even though the buyer does not wish to assume the benefits of the contract.
The importance of reviewing contracts cannot be overemphasized. One new hotel owner learned that the hard way. About two months after he had acquired a hotel, he received a bill for more than $30,000 from the local highway commission. The bill was for a billboard sign near the property, which advertised the location of the hotel. The new owner had no idea that this sign did not “run with the land,” and that it was not available to him unless he paid a new fee. The agreement for the sign specified that upon any transfer of the hotel, the highway commission had the right to take down the sign unless the new owner paid a new fee. Because the buyer did not have a provision in his agreement of sale that obligated the seller to disclose all contracts affecting the hotel, the buyer did not learn about the need to pay for the highway sign until after he had purchased the property
Suppose that your seller is leasing furniture for the hotel, but is several months in arrears in his rental payments at the time that you close. Assume that you have stated in your agreement that you are not responsible for the seller’s liabilities arising prior to the date you acquire the hotel. Are you adequately protected?
From a legal standpoint, you may not have any obligation to the lessor of the furniture after closing. However, as a practical matter, if you are not aware of these arrearages at the time that you buy the property, you may receive a call from the lessor after closing, saying that he will confiscate your furniture unless you pay the amount due from the seller. This would put you in a situation of either having to pay the seller’s charges, or risking interruption of your business if the lessor took back its furniture before you were able to replace it. To avoid this situation, make sure to do a thorough audit of the seller’s books and records in advance of closing, and try to force the seller to provide you with evidence he has paid his obligations, even if you are not going to assume them, prior to closing.
If the hotel you are acquiring has banquet or meeting facilities, there are probably events that are booked, and for which a deposit has been made, that will occur subsequent to your acquisition. Before executing the agreement of sale, try to obtain a complete list of these events. Since most likely you will be obligated to honor the seller’s commitments, be certain that the events are profitable and the deposits for the events are assigned to you. It is also a good idea to notify the parties who have booked the events that you will be taking over the hotel, that you intend to honor their contracts, and that you will be available to service the needs of the parties who will be using your facilities in the future.
Taxes present the most complicated type of seller liability facing the buyer when negotiating an agreement of sale. Obviously, you do not want to assume any of the seller’s tax liabilities. However, it is often difficult to determine what those liabilities are, particularly in circumstances where the seller has been paying taxes on an estimated basis or has not yet filed an applicable tax return. At a minimum, you should obtain the seller’s representation and warranty that no lien exists or can be asserted against the real estate that you are buying because of the failure of the seller to file a tax return or report or pay applicable federal, state or local taxes. Many states and municipalities issue lien certificates or other documents that verify a seller’s tax liability. There should also be a provision in the agreement of sale that obligates the seller to pay any taxes assessed subsequent to the closing, but which relate to the seller’s ownership of the property. In cases where taxes are paid on an estimated basis (such as sales tax or unemployment insurance premiums), there may be an adjustment which is not made until after closing, but which should remain the seller’s responsibility. Be particularly wary of the types of taxes that run with the land or business that your are acquiring, and which may become your obligation, by law, if they are not paid by the seller. Many states have “bulk sales” laws which must be complied with if the buyer is to avoid liability for the seller’s taxes, when the buyer is purchasing substantially all of the seller’s assets. A lawyer or accountant can be particularly valuable in this setting, and it is imperative from the buyer’s perspective that the issue of the seller’s tax liabilities be addressed.
The Seller should provide the buyer with a list of employees, including job title, social security number, wages, salaries, bonuses, vacation, sick pay and other benefits payable to the employee at the time an agreement of sale is signed and at the time of closing. The seller should be responsible for all of the accrued wages, salaries, bonuses and benefits that the employees have not been paid and which relate to the period prior to closing. You should also investigate whether there is a union or collective bargaining agreement in effect with respect to any of the employees, and whether there have been any attempts or efforts to organize any of the employees into a union. The union status of a hotel’s employees is critical to establishing a budget for future expenses and determining the price you are willing to pay for a hotel. A collective bargaining agreement may be binding upon you as a buyer, even if it has been negotiated by the seller. If there is such a contract in place, review it and its ramifications upon your acquisition.
You can obligate a seller to pay for all of the liabilities that are incurred during the seller’s ownership of the property, but what if the seller simply doesn’t pay? What can you do to protect yourself under these circumstances? First, you can establish an escrow at closing to pay for known and unknown liabilities of the seller, which may arise after the closing. You can establish a term for this escrow that is consistent with the period of time it will take to determine the seller’s complete range of liabilities.
Second, you can obtain the seller’s obligation to indemnify, defend and hold the buyer harmless from and against the seller’s liabilities. This will allow you to recover your losses from the seller in the event you pay the seller’s liabilities, as well as your attorneys’ fees and costs in litigating disputes concerning the seller’s liabilities.
Finally, you can attempt to obtain a guaranty from a financially responsible party of the seller’s continuing obligation to pay his liabilities. In many instances, the seller will be a “single purpose entity,” whose only asset is the hotel that is being sold to you. Once the asset is sold, the seller will likely cease doing business and will liquidate the proceeds from the sale. It would then be very difficult to obtain compensation from the seller if you were to pay his liabilities after closing. If the individuals who own the selling entity or another financially responsible entity controlled by these individuals provide you with a guaranty of the seller’s liabilities, you will have the added protection of knowing that a party with real assets will be available to compensate you for your losses.
When buying a hotel, do not overlook the past and focus solely on the future. Examine not only the performance of the property from an income and expense standpoint, but also the current status of liabilities and how you are going to deal with them. By insisting on disclosure of these liabilities, and the seller’s acceptance of financial responsibility, your acquisition of the property and the hotel business will be accomplished smoothly and without significant transition costs.