Canada: The Effects Of COVID-19 On Hotel Financing

The global COVID-19 pandemic has particularly affected the hospitality industry. To address some of the issues arising from the COVID-19 pandemic, hospitality industry participants have been forced to revisit the terms of their existing financing, brand management and franchise agreements and to engage in discussions with other stakeholders to build a path forward.

1. Many hotels have faced closure due to the pandemic. For hotel properties that are currently financed, what are some of the key issues being addressed by borrowers and lenders under hotel credit agreements?

Borrowers will principally be focused on obtaining payment deferrals—of principal, at minimum—or other liquidity relief, but borrowers should also review the terms of their credit agreements to consider whether there are any existing covenants in respect of which they should seek waivers from their lenders. Does the credit agreement include: (i) continuous operating covenants; (ii) financial covenant requirements, including regular testing and reporting of compliance with such financial covenants; or (iii) requirements to make regular payments into a furniture, fixtures and equipment (FF&E) reserve fund, or to make property improvement plan (PIP) renovations as required by a hotel brand?

Given that the pandemic is an extraordinary event, resulting in an uncertain market environment, to date many lenders have been inclined to work with their borrower clients on finding a solution going forward, particularly where the borrower is proactive, transparent and cooperative. It is helpful for borrowers to present their lenders with their immediate plans to preserve cash flow—by seeking deferrals of taxes or rent, for example—together with their plan for navigating the next 18 to 24 months, and attempting to re-attain some significant percentage of their pre-COVID-19 levels of performance. This information will assist lenders in deciding whether a waiver should be granted and, if so, the period of time that would be appropriate for such waiver. Lenders may also be asked to consider whether their borrower clients can use some of the funds in their FF&E or PIP reserve funds or management fee accruals for working capital purposes, in order to assist the borrowers in navigating short-term liquidity issues.

Depending on the nature of the relief requested by the borrower—particularly if the borrower is requesting the deferral of principal and/or interest payments, or other liquidity relief measures—the lender may require that the sponsor(s) of the borrower share the risk with the lender by injecting additional equity into the project, or by providing a recourse guarantee and/or demonstration of the sponsor's minimum liquidity. Lenders will also require borrowers to continue to maintain insurance coverage and to continue paying amounts that take priority over the mortgage, such as payment of realty taxes, subject to any deferrals that may be granted by or negotiated with municipalities. In addition, lenders will require that permitted distributions be restricted, such as no payment of distributions, dividends, fees or other types of payments—for example, management fees or intercompany debt payments—to borrower's shareholders, sponsors or related entities.

2. If a hotel is subject to a brand management or franchise agreement, how is the brand manager or franchisor able to help owners and franchisees?

Many hotel owners have been engaging with their brand manager or franchisor to discuss how they can provide assistance to hotel owners in navigating the COVID-19 pandemic. Brand managers and franchisors may be able to offer fee relief, defer cycle renovations, waive required funding of FF&E reserves, suspend brand standards/initiatives and suspend brand standard audits. For example, Marriott and Hilton are both providing fee relief under certain circumstances, relaxing or suspending brand standards and suspending or adjusting the frequency of their brand standard audits. To assist the hotel owner with liquidity, the brand manager may also allow the hotel owner to use some of the funds in the FF&E or PIP reserve funds or management fee accruals for working capital purposes.

If the brand manager or franchisor is willing to assist the hotel owner, the hotel owner should consider whether the consent of its lender is required in order to institute any such deferral. Typically, the brand manager or franchisor has agreed not to amend the terms of the management agreement or franchise agreement without the consent of the lender, pursuant to a subordination and non-disturbance agreement between the brand manager or franchisor and the lender.

3. Are there further issues borrowers should consider in relation to real property interests?

Depending on the nature of the real property interest involved, a borrower will also want to consider other relevant issues. If the hotel is situate on leased lands, the borrower will want to ensure that the ground lease is kept in good standing, or ensure that an acceptable deferral of rental payments is negotiated with the ground landlord, with the consent of the lender. If the hotel is a condominium hotel—where a majority of the hotel units are owned by the hotel operator, but where a number of other hotel units are owned by separate third parties—the hotel operator will need to consider how to ensure that the third-party owners contribute to the obligations and payments required by the lender—for example, the timely payment of realty taxes. If the hotel includes a casino, the borrower will need to consider whether the government mandated closure of casinos constitutes a "force majeure" event under the casino operating agreement.

4. How can the recently announced federal government programs be employed by hotel owners, operators and lenders?

Since the earliest announcement of the pandemic in Canada, we understand that the Hotel Association of Canada, together with other hospitality partners, have engaged in federal and provincial advocacy in order to ensure that all levels of government have a better understanding of the hospitality sector and how it has been impacted. Their advocacy continues with a view to encouraging recovery/relief packages and/or incentives specifically targeted to the hard-hit hospitality sector.

The existing government programs enumerated below may provide some relief to hotel owners and operators.

The federal government has made certain government programs available which can be employed by the hospitality industry. The Canada Emergency Wage Subsidy Program (CEWS), which launched on Monday, April 27, 2020, provides eligible employers with subsidies of 75 per cent of employee wages for up to 12 weeks, retroactive from March 15, 2020, to June 6, 2020. All hotels that have experienced a decline of at least 15 per cent of their revenue in March 2020 and 30 per cent or more for subsequent months are eligible for this program. Seasonal businesses may also be eligible for this program, as decrease in revenue can be calculated either by comparing gross revenues from a specific month in 2020 against the gross revenues of the same month in 2019, or by comparing revenues in March, April, and May 2020 to an average of revenues in January and February 2020. Hotels which have not yet experienced a sufficient drop in revenue, but which anticipate experiencing such a drop in the near future, may not yet be eligible for this program.

The Business Credit Availability Program (BCAP) provides additional support to businesses through the Business Development Bank of Canada (BDC) and Export Development Canada (EDC). BDC and EDC are working with private sector lenders to coordinate on credit solutions for individual businesses, including the Loan Guarantee for Small and Medium-Sized Enterprises, whereby EDC is working with financial institutions to guarantee 80 per cent of new operating credit and cash flow term loans of up to C$6.25-million to small and medium-sized enterprises (SMEs), and the Co-Lending Program for Small and Medium-Sized Enterprises, which is available until September 30, 2020, whereby BDC is working with financial institutions to co-lend term loans to SMEs for their operational cash flow requirements.

Eligible businesses which paid an annual payroll of C$20,000 to C$1.5-million in 2019 may borrow up to C$40,000 through the Canada Emergency Business Account (CEBA) mechanism. No interest will be payable in respect of such loans in 2020, 2021 or 2022. Interest on such loans would begin to apply on any outstanding balance at an annual rate of five per cent, payable monthly, starting January 1, 2023, for the remaining three-year term until the end of 2025. Businesses who repay 75 per cent of the outstanding balance on or prior to the end of 2022 will have the remaining 25 per cent balance of their loan forgiven, to a maximum of C$10,000.

In addition, C$675-million has been allocated by the federal government to provide financing support to small and medium-sized businesses that are unable to access other COVID-19 business supports, through Canada's Regional Development Agencies.

The federal government has also reached an agreement in principle with all provinces and territories to implement the Canada Emergency Commercial Rent Assistance (CECRA) program to provide rent relief for small and medium-sized businesses that have been impacted by the COVID-19 crisis and CECRA promises to lower rents for eligible tenants by 75 per cent for payments due in April and May, retroactively, and June.

The Canada Emergency Response Benefit (CERB) provides eligible employees or contractors who have stopped working because of COVID-19 and do not qualify for traditional benefits, such as Employment Insurance, with temporary income support of C$500 a week for up to 16 weeks. Hotel owners and operators have reported instances of employees voluntarily leaving their jobs to go on CERB.

5. Are there new sources of income available for hotel owners?

The impact of the global COVID-19 pandemic has forced hotel owners to consider how to generate new sources of income using their hotel properties. Hotels have had success partnering with the federal government and certain provincial and municipal governments, including the B.C., Saskatchewan and Manitoba provincial governments and the City of Toronto, to temporarily house hospital patients, homeless residents and front-line healthcare workers during the COVID-19 pandemic. In the U.S., more than 15,000 hotels signed up for the American Hotel and Lodging Association (AHLA) Hospitality for Hope initiative, which facilitates partnerships between the hospitality industry and governmental organizations by matching hotels with government agencies in need to allow hotels to offer temporary housing for emergency and health care workers amid the pandemic. Certain hospitals have also partnered with hotels to have rooms retrofitted to provide accommodation for hospital patients. In addition, certain hotels have had success obtaining private donations to fund initiatives to use hotel rooms to provide temporary accommodation for front-line healthcare workers. Logistical concerns involved in moving homeless persons, hospital patients and/or front-line healthcare workers into hotel rooms include room retrofits, the installation of additional safety and security precautions, and providing enough food and hiring the necessary security, staff, cleaning services and case managers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.