Baker & McKenzie Comments on Working Through the Complexities of the Hotel Sale Process - Insights for Sellers and Buyers - By Graeme Dickson, Roy Melick and Robert Williams, Baker & McKenzie

From 13 to 15 October 2010, the hotel industry once again converges in Hong Kong for the 21st Annual Hotel Investment Conference Asia Pacific. The conference begins with a master class titled "Working through the complexities of the hotel sale process – insights for buyers and sellers", which will be moderated by Baker & McKenzie partners, Graeme Dickson and Robert Williams. Another Baker & McKenzie partner, Roy Melick will also be speaking in a separate workshop titled "Due Diligence Pitfalls".

In advance of the master class, we have prepared an article (presented in two parts), where we explore the topic from the seller's perspective in one and, in the second part, the buyer's perspective. We are fortunate to have obtained comment from a number of senior industry participants. In this article, we are pleased to have received contributions from Craig Collins, Managing Director Australasia (formerly Managing Director – Investment Sales Asia), Jones Lang LaSalle Hotels and Andrew Heithersay, International Director – Head of Acquisitions, Asia Pacific (ex Japan), LaSalle Investment Management on the most important matter for the seller to bear in mind.

We look forward to catching up with many of you at the conference.

Background

About two years ago, we published an article "The Top Ten Decisions You Need to Make on Hotel Business Sale Agreements". Given the volume of transactions our specialist hotel lawyers have been involved in over the intervening period, which approximates in deal value in the billions of US dollars in the Asia Pacific region alone, we felt it would be beneficial to pen another article on this important topic – but with a different emphasis.

In the 2008 article, we focussed on the key technical aspects of a hotel sale transaction, such as how to structure the transaction, warranties, inclusions and exclusions, employees, adjustments etc. In this article, we focus on the learning we have picked up over many years acting for both sellers and buyers to, in short, WIN.

For a seller, this means selling its hotel for the best price and on the best terms attainable in the prevailing market efficiently and without surprises. For a buyer, this means crafting the competitive bid process to present to the seller the most attractive purchase proposition – not just in terms of price, but in every aspect of the purchase equation.

We have been involved in transactions where careful planning and meticulous execution have culminated in a successful outcome for both sellers and buyers. Equally, we have witnessed transactions where mediocre planning and/or sloppy execution have had the opposite effect of what should otherwise have been a successful campaign.

In this article, we will look at the transaction from the seller's side and then switch tack to the buyer's side on the second part of the newsletter. This article represents the personal views of the authors.

The seller's battle plan

"Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win.", The Art of War by Sun Tzu, 600 BC

There are 10 factors which we consider should be front of mind when entering into a successful selling campaign.

Choice of consultants – the seller must control the sale process from the outset

As active consultants, this is obviously an aspect of the article where total objectivity is not possible. Nonetheless, it is one of the most critical parts of the process to get right. The starting point is to identify the expertise, which is required. In addition to the lawyer, some of the consultants that may be required include the accountant, tax expert, engineering consultant, environmental consultant, valuer, liquor licensing consultant and employment consultant. In broad terms, a seller is seeking to access expertise, which it does not possess, but is needed to achieve the most attractive sale proposition.

What should the seller expect from each consultant?

Obviously, experience and track record are critical. It is always better to take advantage of the expertise that somebody else has paid to develop. However, we consider that the discriminating seller should also seek to engage consultants that have a clear view, based upon their experience and expertise, on the way the process should be undertaken to derive maximum benefit to the seller.

Once each consultant has articulated its vision for the sale process, all the various approaches should be appraised by the seller and, ideally, harmonised to achieve one uniform comprehensive plan of action for the sale process.

It is absolutely critical that the battle plan devised for the sale process produces the result where the seller remains in complete control of the process, from inception to finalisation.

In our view, the seller should identify one key individual to control the sale process and marshal the activities of all the consultants as well as the seller's own personnel. In our experience, a committee performing this function is an inferior alternative. One person needs to have the power to make decisions quickly and decisively with the knowledge that he or she will be rewarded for the correct ones and berated for the bad ones. If the process is not controlled properly, it can quickly lead to a less than ideal sale outcome, including the prospect of irate buyers and nasty cost blow-outs.

How to approach the due diligence process – simple, straightforward and user-friendly

"Before offering a hotel to the market, identifying the hotel's potential upside is key. Being able to demonstrate to a purchaser how the asset can produce a stronger profit through value-add or market opportunities gives them greater capacity to maximise their bid price.", Craig Collins, Managing Director Australasia (formerly Managing Director – Investment Sales Asia), Jones Lang LaSalle Hotels

The seller must seek to make the whole sale process as simple, straightforward and user-friendly as is possible in the prevailing circumstances. The seller should put itself in the shoes of the buyer and anticipate and, where possible, answer the questions the buyer will ask before they are asked.

This is particularly the case on the due diligence process. Typically, the contemporary due diligence environment is not physical, but internet-based. It requires highly competent expertise to set up and populate the due diligence site (both initially and throughout the sale process as new or updated information becomes available) in an intuitive way for the reader. Easy and convenient access also needs to be arranged for the myriad of people from both the seller and buyer-side.

Due diligence for a hotel sale, which is essentially a business sale transaction (as opposed to a straight property sale), is almost invariably a complex undertaking. There are usually complicated land and title issues, hundreds of employees, and a multitude of service and accommodation contracts to be gathered, collated, understood and processed. The method of identifying relevant information starts with the all important checklist of due diligence items and moves through to the collection, compilation and indexing of the volumes of due diligence materials. This work needs to be handled in military fashion by competent people who understand the underlying relevance of the material. The information should also be put together in a logical and easy-to-find manner. The process of updating the due diligence material should be thought through from the outset to ensure that, from the time this process is rolled out, it does not have the potential to create confusion or concern to the seller's staff or consultants or to the small armies of consultants who will inevitably be engaged by each of the buyers.

There is no finer compliment for a seller and its consultants than an unsolicited gem from a buyer who makes a point of commenting positively on how well the due diligence process was put together and was executed in a manner, which made it easy for the buyer to quickly come to a view as to the true value of the target hotel. This is to be contrasted with the comment that it was necessary to low-ball the purchase price, because the due diligence materials were poor and raised many areas of potential exposure and unforseen cost, which required the buyer to adopt a very conservative pricing strategy .

The quest for a balanced sale contract – do not hand the process over to the lawyers

There are many ways that the process of drafting the hotel sale contract can be approached.

One approach, which has relatively widespread appeal, is to draft the contract in a very (even excessively) seller-friendly manner. In our view, this approach is ultimately incompatible with the prime objective – the attainment of the best possible sale price in the context of the best possible sale terms.

We acknowledge that this is a potentially controversial comment and appreciate that there will be many readers – both lawyers and others – who will take issue with our view. We have advocated this position on many occasions and, based on our experience, consider that it is absolutely the right way to proceed. If the sale contract is drafted in a manner, which is very seller-friendly, then this will invite a buyer's lawyers to propose wholesale and comprehensive changes to the document. This not only has the potential to hand the process over to the lawyers, it makes it much more difficult for the seller to compare competing offers. On top of all the other differentiating factors between, say, the first and second buyer, the seller may need to take into consideration a large shopping list of proposed contract changes. Furthermore, it will be much more difficult to enter into an exclusive arrangement with one buyer, where the deal could run into one of these many points of disagreement, require the seller to revisit the bid proposals of all the other buyers and, in the process, take into consideration the large list of proposed (and in all likelihood disparate) amendments advocated by each of these other buyers.

For these reasons, we strongly advocate that the sale agreement should be drafted in a manner, which is both reasonable and fair to both the seller and buyer. This approach, if implemented by the seller, becomes a foundation of the sale strategy for reasons we will discuss further below. When the document is uploaded to the due diligence platform, it is usually accompanied by a covering letter stating that the seller has instructed its lawyers to draft the agreement in a fair and reasonable manner. As a consequence, the seller is expecting the buyers to accept the agreement without amendment (or at least as few amendments as possible). It is also made absolutely clear that any proposed amendments will constitute demerits to the attractiveness of the buyer's bid .

Of course, to succeed, this cannot just be a ploy on the seller's behalf. If the covering letter says that the draft agreement is fair and reasonable, then it must be so. Otherwise, the credibility of the seller, and its consulting team, is damaged and the seller most likely will lose control of the sale process.

Once the scope for amendment to the sale agreement is tied in to the competitiveness of each buyer's bid, then the scope for a buyer's lawyer to act wantonly on the sale agreement is substantially eliminated for most serious buyers. There is no point in a buyer's lawyer engaging in a point-scoring exercise if the upshot of this approach is that his or her client's bid is marked down.

In our view, it is better to be a successful strategist than an unsuccessful point scorer.

Avoid unnecessary and counterproductive documents or activities – determine what is (and is not) important

The best way to explain this point is with an example.

On a high-profile transaction, the decision was made that before any buyer was entitled to receive an Information Memorandum, they were required to execute a confidentiality agreement (Confi). This not only covers its own personnel, but any consultant that it was intending to disclose the Information Memorandum to.

The Confi was to be very tightly worded and was to be executed not only by the buyer, but by all persons to whom the Information Memorandum would be shown, including all personnel engaged by any consultant as well as lawyers.

Whilst the underlying rationale of this approach from the seller's perspective was sensible, in retrospect, it turned out to be totally inappropriate, counterproductive and at a huge cost for all concerned, particularly to the seller.

In reality, it is very difficult to enforce a Confi, particularly in circumstances where there are a significant number of parties who have been provided with an Information Memorandum and in quantifying any damage that arises from the breach. Also, of course, if there has been a breach, the relevant information has been disclosed.

Furthermore, because of this stringency, there was significant push-back from almost all the buyers. This ranged from a significant number of proposed amendments to an outright refusal to execute the document – particularly by lawyers. This created a very antagonistic and counter-productive environment at the outset of the transaction, which could have been avoided.

We critically review each aspect of the sale transaction to ensure harmony with the sale process as a whole. In the case of Confis, we strongly advise that the seller adopts a significantly less Draconian approach and, in particular, that persons other than the buyer not be required to specifically execute the Confi. Instead, we advocate that an obligation be imposed on the buyer to ensure that any breach of confidentiality is the buyer's responsibility.

Combined with this approach, we seek to ensure that, as far as possible, the Information Memorandum does not contain any truly confidential information or, if it must, such confidential information is kept to a minimum. The confidential information should only be disclosed to a very small number of shortlisted parties (usually two to four) who are given access to the due diligence room, perhaps after executing a further and more stringent confidentiality document.

Dealings with the hotel operator – ally or adversary

Most hotels, particularly five-star hotels, are operated by independent hotel management companies under hotel management agreements. In the current economic climate, most management agreements will not give the owner the ability to terminate the agreement on the sale of the hotel. As the agreement needs to be assigned to the buyer, the terms of the agreement must be studied closely at the earliest possible stage to determine what restrictions the operator can impose, not only with respect to the buyer, but any secured financier to the buyer. For a consideration of some of the issues to watch out for, please refer to our previous article "The Hotel Management Agreement – Increasing Investor Appeal".

We have previously discussed the nature and extent of many of these restrictions. In this article, we are interested in the dynamics of dealing with the operator to ensure that the involvement of the operator, once again, harmonises with the entire sale process and does not create any issues for any buyer, which could either jeopardize the sale or propose a reduced price.

In our experience, this involves making the operator aware of the proposed sale transaction, and communicating with the operator throughout the sale process, to ensure that the operator participates in a timely and constructive fashion.

Most hotel operating companies accept involvement in the sale process as a necessary aspect of their role as a hotel operator and, if treated the right way, will participate in the process in a positive manner.

Communication with the seller's team members – frank, comprehensive and often

"Integrity is essential for long-term success in business. Be prepared, honest and principled in your negotiations.", Andrew D.S. Heithersay, International Director – Head of Acquisitions, Asia-Pacific (ex Japan), LaSalle Investment Management

This is a fundamental aspect of all successful sale programs that we have undertaken. In a highly complicated transaction, communication is absolutely vital.

This generally means regular meetings (usually weekly and more frequently as the transaction comes to a climax) involving all the key team members. It is absolutely critical that a written agenda is prepared in advance, which seeks to identify key aspects of the transaction process, what is expected to be done and who is expected to do it and by when.

Communication with the potential buyers – keep it formal and focussed

Communication with the buyer and its consultants is as important as maintaining communication amongst seller team members.

At the outset of the sale process, a decision should be made as to who should be communicating with each of the buyers and on what basis. Every transaction will be different and, hence, a different communication protocol will need to be considered and determined in light of the circumstances of each deal.

Obviously, the seller's agent will have the role of primary communicator with the buyers on commercial issues. As far as the lawyers are concerned, the size and complexity of the transaction will dictate the nature and extent of communication with each of the buyers.

Usually, up to the point where shortlisted buyers are determined, communication by the seller's lawyers with the lawyers for any of the buyers should be kept to a minimum.

Once the shortlist has been determined, we favour an approach, which keeps informal communication between the seller's lawyers and the buyer's lawyers to a minimum. To the extent that there is communication, we prefer that it is formalised in some fashion. Generally, when we are acting for a seller, we issue a communication protocol to buyers, which includes a formal Request for Further Information (RFI) procedure. If any buyer requires further information, which usually relates to any of the information contained in the due diligence room, then a formal RFI document needs to be issued to the seller in a manner consistent with the protocol.

As part of the protocol, we usually indicate that we reserve the right when responding to provide the information solely to the buyer that lodged the RFI or to broadcast the information to all buyers. We also reserve the ability not to respond to any RFI, which we consider to be irrelevant or immaterial.

There is a tendency in large transactions for aspects of the due diligence exercise to be delegated to junior lawyers who may not necessarily have a significant understanding of what their client is seeking to achieve from the due diligence process. In a number of transactions that we have been involved in, this has resulted in a junior lawyer accessing firm precedent documents and providing a significant number of RFI requests, which the seller's lawyers consider are inappropriate and/or irrelevant. For example, in one transaction, we were aware that a portfolio of hotels was to be sold in one line with a sale value in excess of US$500 million and a significant number of RFIs were issued by one of the buyers relating to a flag pole located on the top of one of the hotels. On any assessment, these enquiries were entirely irrelevant to the sale as a whole. In our view, it is incumbent upon a senior lawyer acting for the seller to make contact with that person's counterpart to make it clear, from the seller's perspective, that such a line of enquiry should be reconsidered and perhaps a more senior lawyer brought in to oversee aspects of the due diligence process.

Determine the benefits of funding buyer legal costs – do not be penny wise, pound foolish

This is always a difficult issue. Usually, the approach is for a buyer to fund its own due diligence costs. So why should a seller consider making a funding contribution? In our experience, this becomes a significant issue in two distinct situations.

First, where one buyer shows keen interest in the hotel with one or two others showing lukewarm interest. The seller and its consultants may conclude that it is worthwhile funding the buyers in an attempt to ensure that competitive tension between the buyers is maintained.

Secondly, there is the situation, which has become more acute in the wake of the Global Financial Crisis, where there are only a few buyers with the financial capacity to consummate a transaction (due generally to the lack of available bank finance). These parties have become very selective, and funding due diligence costs has become an important element in inducing them to undertake due diligence on the target hotel.

Once the decision is made to make a funding contribution, consideration then turns to the amount and terms. Usually, the funding contribution is a specified amount, which is calculated as a percentage of the costs that a buyer would expect to spend on the due diligence exercise. It is also usual to specify that the funding contribution will not be forthcoming, if the buyer reduces its bid or materially changes other terms of its bid, during the sale process for reasons other than those which can be linked to information uncovered during due diligence.

Obviously, the approach that is taken to the drafting of the sale agreements, the condition of the due diligence materials and the other aspects of the sale process factor into the dollar amount of the likely due diligence costs, and hence the funding contribution that needs to be offered to buyers as an inducement to participate in the sale process.

Maintain competitive tension – the most important lesson

The most successful sale campaigns we have witnessed have been those where the seller has been able to maintain competitive tension up to the point where legal documents are signed and the buyer is locked into the sale.

This requires a decision as to when, if at all, the seller goes exclusive with a particular buyer. This can sometimes be hard as each buyer will argue strongly that it is considering pulling out of the race unless it is granted exclusivity.

In our view, this should be resisted strenuously. The other matters we have discussed above come into play to assist the seller in this respect. That is, make the process as simple as possible, keep in constant contact with each buyer, its advisers and consultants, consider funding due diligence costs etc.

The execution of a selling programme requires experience and focus and, if implemented successfully, can result in a sale result which exceeds everybody's expectations. We know because we have been involved in a number of such campaigns. There is a great feeling of both triumph and relief when it all comes together in what appears to be a seamless process.

KISS – and then try to make it even simpler

What a wonderful expression – "Keep It Simple, Stupid" (KISS).

Every seller, and all their key advisers, should keep this guiding principle at the forefront of their thinking at each stage of the sale process. If you make it as easy as possible for each of the buyers, then you are creating the environment for a successful sales campaign.

 

About Baker & McKenzie

Founded in 1949, Baker & McKenzie provides sophisticated advice and legal services to many of the world’s most dynamic and successful organizations through more than 3,900 locally qualified lawyers and more than 5,800 professional staff in 68 offices and 39 countries.  Baker & McKenzie is known for having a deep understanding of the language and culture of business, an uncompromising commitment to excellence, and world-class fluency in the way we think, work and behave.  (www.bakermckenzie.com)

Reader Comments:

Be the first to leave a comment for this article