In brief - in this four-part article, we examine some important issues for hotel operators and owners to help you manage your risk in the face of COVID-19
- What can you do to protect your hotel, guests and employees against possible infections?
- How will certain terms of a Hotel Management Agreement be interpreted between the Owner and Operator?
- What should you consider in your financing documents?
- What do you need to know about insolvent trading and the Safe Harbour Regime?
Introduction
The hotel industry in Australia (and globally) has undoubtedly been one of the most widely affected industries as a result of the continuing global COVID-19 pandemic. While there will be some time before a recovery is witnessed and industry participants are anticipated to work together in these drastic times, we set out some salient and practical considerations for both hotel owners and operators to assist in navigating the current challenging environment.
Part 1: What can you do to protect your hotel against possible infections?
Of course, the health and safety of all who come into contact with the COVID-19 virus is of paramount importance. For this reason, a risk assessment should be undertaken as with any work health and safety matter in the workplace (in this case, your hotel). Employees, contractors and any other workplace participants should be consulted so that the possible risk is well understood. Consider delivering communication to staff about risk identification and mitigation strategies. COVID-19 is a dynamic situation, information is being updated daily. Communication, consultation and strategies should be documented and regularly reviewed as further information becomes available.
For this reason, it is important that employers keep up to date with the latest information. As a starting point, employers should be regularly checking the
World Health Organisation website, and relevant local sites including the
Federal Government website and State Health Department websites for the most up to date information.
The issues to be considered in your risk assessment will vary based on the size and nature of your hotel operations, for example, whether you have onsite restaurant/dining or conference facilities. Whether you directly engage staff or utilise outsourced labour (eg, cleaning services) will also be relevant.
However, as a general guide, when conducting a risk assessment you might consider:
- is your hotel aware of the point of origin of travel for guests? If not, can your hotel mandatorily require guests to disclose their travel prior to arrival? Do you need to amend your terms and conditions of booking and/or staying in your hotel to allow this request to be made?
- do your terms and conditions of stay permit your hotel to ask a person to leave the hotel if they are currently suspected of having come into contact with one or more persons infected with the coronavirus?
- will your hotel accept new guests who are currently required to self-isolate?
For hotel staff specifically:
- what new and/or additional training needs to be provided to staff? For example, do staff working in guest relations know how they can/cannot interact with guests suspected of contracting COVID-19?
- are staff aware of what symptoms they should be looking out for and, if so, who they should report their suspicions/concerns to?
- what contingency arrangements will you need to put in place if staff refuse to attend for work generally and/or to attend to a particular guest or guests due to concerns they may contract the virus?
- is it necessary to increase the frequency and extent of cleaning in and around the hotel? Could you be offer additional protective equipment to cleaning staff?
- is it necessary to limit domestic international travel for staff? If so, does this extend to both work-related and personal travel? Are staff required to disclose personal travel? If so, what steps/actions will be taken in connection with an employee who has recently travelled in an affected area?
For front of house staff specifically (eg, staff interacting with guests and other members of the public, individuals who have recently travelled and may have been exposed to COVID-19), consider making face masks available to those who wish to use them and those who could be considered to be exposed to a higher level of risk (eg, staff with underlying medical conditions, or staff required to have higher levels of close proximity contact with guests).
Shared dining spaces such as hotel restaurants could be places where the virus might more easily spread. Consider what specific risk mitigation strategies could be put in place in relation to food preparation and cleaning. Similarly, hotel gymnasiums (due to guests sweating while exercising) may be more prone to the spread of the virus in which case cleaning and hygiene will become even more crucial.
Consider reinforcing the importance of practising good hand hygiene by:
- placing hand sanitisers around shared water dispensers, coffee and tea facilities, other shared spaces like meeting/conference rooms and business centres and at the reception/check-in counter and signage encourages
- delivering specific training/staff meetings about the importance of hand hygiene and safe use of those spaces and places.
Consider talking to your advisor
Consider how your advisors can help you to carry out risk assessments in your workplaces and provide advice on work health and safety matters, as well as how to manage employee entitlements and directions to take leave, stand down from work and self-isolate.
Part 2: Interpretation of Hotel Management Agreement terms
A party seeking relief for delay or cancellation of contractual obligations due to COVID-19 may seek to rely upon force majeure (FM) provisions contained in the either their supply agreements (which we will not deal with in this article), or to excuse certain non-performance under a Hotel Management Agreement. By way of background, the common law concept of FM acts to protect the interests of parties who are unable to perform their contractual obligations due to circumstances outside of their control. A successful reliance on a clause of this nature will generally limit or exclude a party's liability for losses suffered because of a delay or cancellation of their performance of contractual obligations.
FM clauses (and definitions, which may also take the form of being defined as an "Extraordinary Event", or merely defined as any event that is outside a party's control) are often prescriptive as to what will (and what will not) constitute a FM event. There exists a common law duty to mitigate against the effects of the FM event. Parties should be aware that FM provisions will be strictly interpreted by a decision maker against the rights of the party who drafted the contract. As the large majority of Hotel Management Agreements are provided by the Operator, this is a relevant consideration when an Operator may consider relying on the terms of an FM clause.
Performance Test clauses are utilised to ensure that an Operator hits certain target rates in gross operating profit (GOP) when assessed against an annual budget, as well as to ensure the hotel is achieving comparable revenue per available room (RevPAR), measured against a set of geographical and segmentally similar hotels. However, these clauses are generally measurable across at least two consecutive years, which (hopefully) will not be triggered if the COVID-19 pandemic can be limited to a 2020 phenomenon. Further, any breach of a performance test is usually discarded where a circumstance such as an FM event or an Owner's failure to fund operations contributes to such performance failure.
While the financial strain under the Hotel Management Agreement for an Operator will largely be limited to not receiving any Incentive Management Fees (and a large reduction in Base Fees), an absolute obligation on an Owner to fund the hotel's operations are enshrined in Hotel Management Agreements. This obligation is almost always excluded from the operation of FM clauses. An Operator's duties will likely be subject to the Owner discharging its funding obligations under the Hotel Management Agreement. Therefore, if an Owner cannot fund any budget shortfall or otherwise discharge an obligation relating to required funding, this will almost certainly place an Owner in breach of the Hotel Management Agreement (which if continued, will lead to a right for an Operator to terminate). It is for this reason that an Owner should carefully consider its financing arrangements in the current COVID-19 climate.
Part 3: What should you consider reviewing in your financing documents?
There has been a lot of discussion surrounding force majeure but what other provisions in your financing documents may be impacted by the global COVID-19 outbreak?
Documentation may include provisions relying on the concept of "Material Adverse Effect", particularly used as repeating representations and warranties and default events.
While some facility agreements may have a negotiated position on when Material Adverse Effect is enacted, if your facility agreement defines a Material Adverse Effect to include an event that is likely to impact an obligor's (usually the borrower, any security providers and guarantors) ability to perform its obligations under the facility agreement and any relevant documents, you could be facing a review of your facility and its terms. These provisions are sometimes viewed on the basis as a group as a whole or the borrower only.
By way of background, lenders did not seek to rely on the Material Adverse Effect clause during the time of the global financial crisis over ten years ago, and it is our view that it is unlikely that they will enact these provisions in this situation, but borrowers must be aware of when and in what circumstances Material Adverse Effect provisions are triggered under their facilities.
Breaches of financial covenants, representations and undertakings
One other important consideration for borrowers is what financial covenants are contained in your financing documents and are any of these likely to be breached as a result of downturn in supply and demand due to the COVID-19 outbreak. This is particularly relevant for the hotels and tourism industry. It is these provisions that will likely be under scrutiny as they are based on objective data rather than the discretion of a lender.
Certain financial covenants require a borrower (and possibly other obligors) to demonstrate to a lender that it can maintain the financial covenants to which it may be bound. The particular financial covenants that may be triggered as ones which are geared towards earnings and servicing ratios, including interest coverage ratio or those that are benchmarked on an EBITDA multiple.
Each borrower should be reviewing and considering their facilities in light of the global challenges, not only in respect of supply chain dependencies but by conducting a broader risk assessment approach. While we hope that there is a light at the end of the tunnel with a vaccine to hopefully come out in 2021, procedures and plans need to be put in place now in order to withstand the volatility that lies ahead.
Further, borrowers will need to bear in mind that if any part of its business ceases or suspends any work or business in its ordinary course (usually subject to a materiality threshold), this may too trigger a breach of certain representations and undertakings. Hotel operators and hotel owners must specifically consider their obligations under their financing documents if, as a result of reduction in supply of goods and demand from customers, closure of some or all of their business will be required.
Consider seeking legal assistance
You should consider seeking legal assistance in considering and actioning a business continuity plan to help you navigate the next 12 months or longer in order to implement a strategy to prevent a breach of your covenants, representations and other undertakings.
Part 4: What do you need to know about insolvent trading and the Safe Harbour Regime?
Australia has some of the toughest laws in place against insolvent trading and while directors generally have a duty to act in the interests of shareholders, if a company gets into serious financial difficulty then directors have a heavy duty to act in the best interests of creditors rather than shareholders.
However, the position for directors has improved somewhat as a consequence of the Federal Government passing the Safe Harbour reforms - provided the Safe Harbour regime is followed closely. If Safe Harbour is properly utilised, directors are likely to maximise repayments to creditors and preserve equity value.
Some of the steps that a company's board needs to undertake to correctly utilise Safe Harbour include:
- ensuring that the accounts and records of the company are in order and also ensuring the board is properly informed as to the company's financial position
- engaging an appropriately qualified external adviser
- with the assistance of its external adviser, adopting a corporate restructure plan that clearly sets out a process of getting the company's finances into proper order. That corporate restructure plan can be flexible and can change as economic factors change. However, a plan cannot be utilised if the company:
- has failed to pay employees' entitlements when they became due, and/or
- has failed to lodge returns, notices and other documents as required under the taxation laws
Nevertheless, even here if the breach was due to exceptional circumstances or is in the interests of justice to allow the Safe Harbour to proceed, a Court may overlook those issues.
Corporate restructure plan must meet the better outcome test
One further critical element of the Safe Harbour regime is that the plan must meet the "better outcome analysis". In other words, the plan that is implemented must be capable of demonstrating that it is reasonably likely to lead to a better outcome for the company than the appointment of an administrator or liquidator would.
It is, therefore, highly important that the person engaged in developing the safe harbour plan is someone who has a significant skillset in insolvency and can document why the plan passes the better outcome test. If that cannot be documented then the potential protections otherwise available under the safe harbour regime fall away.
If the plan, properly implemented, still fails, directors will not be personally liable for debts incurred after the date of insolvency. If it succeeds then the board ought to be commended. In the context of the COVID-19 emergency, the stigma normally associated with the need to call for assistance surely will not apply and with the right expert and a proper plan the business may, as we say, be turned around.
Final thoughts
It is expected that, where available, industry participants will work closely together to navigate a way through this limited but unprecedented event which the industry is currently experiencing. However, with a view to limiting further financial stress, it is important that Owners and Operators of hotel businesses are aware of the various issues which must be thought through in order to assess the next available steps. Industry participants should consider seeking legal advice on how best to deal with current pressures and your individual circumstances to assist you in planning an achievable way forward.