What is the real benefit of an NDA?

The purpose of a NDA is to bring an owner's financier in to a direct contractual relationship with an operator engaged by the owner pursuant to a hotel management agreement (HMA).

In the absence of a NDA, should a financier appoint a receiver or otherwise take possession of a hotel then usually this entitles the operator to terminate the HMA and vacate the hotel. Concerned by this prospect, Australian financiers generally require a NDA to effectively prevent the operator from terminating the HMA so long as the financier continues to comply with the owner's obligations pursuant to the HMA. This gives the financier the comfort and certainty that the operator will not abandon the hotel. Importantly, the NDA also gives the operator the right to ongoing management fees and the right to have the HMA transferred to an incoming purchaser should the financier elect to sell the hotel (which is almost always, if not always, the case).

The question must be asked however, why are financiers so concerned that an operator will wish to terminate a lucrative HMA just because the financier has taken control of the hotel. After all, the financial standing of most financiers is generally greater than most owners. If the financier agrees to continue to comply with the owner's obligations until the hotel can be sold, we would be very surprised if any operator would pass up on this opportunity to receive  ongoing management fees and preferential positioning in any sale curtesy of being the incumbent operator.

What is the real cost of an NDA?

Most HMA templates issued by an operator, as part of the HMA negotiation process, provide that any financier which an owner elects to deal with must enter into a NDA in a form prescribed by the operator. If the owner negotiates hard it can usually water this obligation down from an "absolute" obligation  to a "reasonable efforts" obligation to overcome the possibility that the owner's preferred financier may object to the form of the operator's standard form NDA and the financier and operator are unable to agree on the precise form of the NDA.

In our view the owner should consider an even more attractive position - no obligations with respect to an NDA at all.

The reason for this is simple. It is generally considered the case that a hotel sold with vacant possession will fetch a higher price than a hotel sold subject to an HMA with an incumbent operator. There are many reasons for this including:

• A sale subject to retaining the existing operator reduces the number of available purchasers as the incumbent operator's HMA usually prohibits sale to a competitor and hence it excludes operators from the mix who usually can pay more than owners (because they do not have to pay substantial ongoing  management fees).
• If the operator is underperforming then any rational purchaser will discount the price it is otherwise prepared to pay to take into account the impact of such underperformance.
• The operator may wish to block the sale to a particular prospective purchaser who is prepared to pay top dollar (even if not a competitor) or, conversely, an otherwise very keen prospective purchaser loses interest in the hotel if required to take on the existing operator for reasons including the fact that it has had a bad experience with that operator in the past.

Anecdotal evidence suggests that a hotel sold with vacant possession can sell for more than 10% over the price which is obtainable if the hotel is subject to a HMA and significantly more than that if the operator is under performing.

For financiers, the benefits associated with an NDA are generally not diminished by the prospect of a lower sale price by virtue of the inability to have a vacant possession sale. Financiers will usually lend up to approximately 55% of hotel value. Any diminution in sale value bought about by a sale subject to an incumbent operator would usually not erode 45% of the value of the hotel at the time that the financier's loan was negotiated.

The fact that Australian financiers insist on a NDA is not a universal position. In Indonesia, for example, no financiers are prepared to enter into a NDA. It is not clear to us why this stark difference in approach exists.

Hotel value erosion is significantly more important to the owner. For a hotel valued at AUD 100 million an inability to effect a vacant possession sale could result in a loss of sale price of perhaps AUD 10 million or more. As this is generally in addition to moneys repayable to the financier, some or all of this amount would be available to the owner taking into account all other debts owed by the owner (including any claim for damages that the operator may wish to make as a consequence of the financier's actions).

If a financier cannot present a strong case in favour of agreeing to a NDA and an owner can prove hotel sale value erosion as a consequence of the financier's insistence on an NDA, could the owner have the basis of a claim against the financier as a consequence  or is this just a commercial negotiation issue? This is obviously a significant issue for not only financiers and owners but also operators and their respective advisers. A detailed analysis of this point is beyond the scope of this newsletter.

Summary and conclusions

When an owner negotiates a HMA obviously it should aim to put itself in the best possible contractual position. There are many matters to consider. Some are more obvious than others.

In our experience many owners are far too relaxed in agreeing to an owner requirement that it has any obligations whatsoever in relation to the existence of an NDA. There seems to be absolutely no benefit to an owner to agree to NDA obligations and, as we have sought to explain in this newsletter, the cost can be significant.