Part 4: What’s Yours and What’s Mine?
In the first three posts in this series, we reviewed the basics of a hotel PSA, we then got into pricing and the Due Diligence (DD) period, and we then moved onto the closing process and assets covered in the sale. We will now move onto the details of potential pricing adjustments, prorations, determining the legal responsibilities of the Buyer and the Seller, and briefly describe what may occur in the unfortunate event that the transaction is not completed.
Adjustments and Prorations
Throughout the DD process, there may be unanticipated items discovered, e.g., a leaky roof in need of repair or a major mechanical system that is not operating at peak efficiency. It is important to describe in the PSA how such issues should be handled and what remedy can rectify the situation. Is it incumbent upon the Buyer to make the repairs at Buyer’s expense before the transaction closes? Perhaps the Buyer instead offers a credit in the form of a price reduction for the overall transaction. Or if the sale is as-is, then the Seller understands that it will be the Seller’s responsibility after the transaction closes to remedy these situations.
It is also important to determine how prorations will be calculated and by what date this will occur. As a reminder, prorations is the process through which the Seller and Buyer determine who is responsible for each portion of expenses that occur in the month when the transaction is scheduled to close. For example, occupancy taxes may be due by the last day of the subsequent month, i.e., occupancy taxes for October would be due by the last day of November. If the transaction is scheduled to close on October 15th, it is important to spell out the process and the exact amounts owed by each party on November 30th. Will the Buyer make the payment and be reimbursed by the Seller? Will the Seller make the payment and be reimbursed by the Buyer? Will each party make its own partial payment? Whatever process is used, it’s best to have it detailed in the PSA so there is no confusion. Keep in mind that there may be many such items to be prorated including utility bills, F&B purchases, team member wages, lease payments, and other monthly expenses of the hotel.
Adjustments also become important for items that may not be due during the close of transaction such as property taxes. For example, assume that your jurisdiction assesses property taxes on a calendar year basis, tax assessment notices are sent out by February 1st of the start of the subsequent year, and the property tax payment is due by April 1st. If your transaction is scheduled to close on January 15th, the Buyer may receive the previous year’s property tax assessment that is the responsibility of the Seller. The PSA should dictate with total clarity that this tax assessment is the responsibility of the Seller and not the Buyer. Additionally, because the transaction closed in mid-January, are the first 14 days of January’s portion of the current year property taxes the responsibility of the Buyer or the Seller? Each transaction is unique and it is important to have this detailed in the PSA to avoid any challenges down the line.
Insurance and Liability Post-Sale
Another important part of the PSA is to determine when liability transitions between Seller and Buyer and over what time period. This is important for many reasons because while this is generally specified as the Closing Date and Time as described in a previous post in this series, it is especially important as it relates to insurance claims after the transaction closes. For example, if the transaction closes on October 15th and there was a slip and fall incident tendered to the insurance company in September, an insurance settlement may not be finalized until well after the transaction closes. Throughout the settlement process there may be requests from the carrier that have nothing to do with the Buyer’s entity as the Seller has the liability for this claim. The PSA should describe what process should be used to ensure that the claim can be processed and that the Buyer does not bare the onus of the claim. It is a good idea, and some PSAs will call this out specifically, that the Seller maintain an insurance tail for a specified period of time, generally a minimum of one year post-close of transaction, to cover any potential claims that may arise. Even if this is not required by the terms of the PSA, it is a good idea for the Seller to maintain this type of coverage to protect against potential future claims that may be costly if insurance lapses or expires.
Default and Termination
While neither side anticipates the transaction falling apart, it is important to detail what process may take place if this occurs. For example, if the Seller is required to turn over all DD files within 5 business days but fails to do so, what is the remedy? What if one party does not communicate with the other for an extended period of time after multiple attempts to be contacted? What if during the DD period the Buyer uncovers items that no longer make the transaction attractive? And if the transaction does cease, must files be returned from the Buyer to the Seller? Is there a break-up fee due to either party for the transaction not closing? While there could be any number of reasons why a transaction may not go through, it is important that the specifics of how the transaction would cease are covered in the PSA to avoid confusion or legal pitfalls down the line.
In the final post in this series, we will review additional items that are covered in the hotel PSA.