Lenders are increasingly moving to take action against borrowers as the COVID-19 pandemic continues and patience wears thin, Pryor Cashman LLP’s hotel practice leader told Law360 in a recent interview.
Todd Soloway, who leads the firm’s hotel and hospitality group, said he expects to see more litigation, as well as more restructuring, as borrowers continue to struggle to make their loan payments.
Soloway, a partner in New York, works on a wide range of real estate, real estate finance and hospitality-related matters. He’s also co-chair of the firm’s litigation group.
Where do you think we are right now in the real estate litigation cycle as it relates to COVID-19?
I think that we’re in a phase that is somewhat reminiscent of where we were in 2008, 2009, where we have a lot … of real estate finance issues, whether they are workouts or foreclosures. Mezzanine loan foreclosures, first mortgage lien foreclosures or workouts. I think we’re heavily in that space. I think the lending community has … been as patient as it can be with some of these assets that are either nonperforming or were nonperforming even pre-COVID, or nonperforming during COVID. … So you’re seeing a lot of distressed real estate finance-oriented litigation and workouts.
What are those workouts looking like? Can you give me a sense of the key questions and how those discussions are playing out?
I would say, broadly speaking, there’s a tremendous amount of capital out there. A lot of dry powder from during the cycle. … A lot of the private equity firms are sitting on a lot of cash after having raised a lot of money during COVID. And as a result, while there are … a number of distressed assets, or distressed deals, there are not a lot of distressed deals being done in the sense that you’re not getting major discounts off, because there’s a huge amount of capital chasing these distressed or workout situations. So I think the hallmark of these deals is that they’re not being purchased or acquired at a massive discount to the value of the loans, and the workouts are happening because there’s so much capital out in the market that it makes the workouts readily available.
You mentioned that you think lenders are starting to lose their patience. How is that going to change things?
For a long time it was forbearance agreements, a lot of kicking the can down the road and some small extensions to loans. Now, you’re seeing litigation, or actually steps taken towards foreclosure on mezzanine loans, … whether it’s lack of patience or [companies] simply saying they’ve waited long enough, or that the defaults have become significant enough that the lending community, the private lending world, or the more institutional lenders, are compelled to take some action to protect their assets.
So as far as this goes to litigation, I know we were talking a lot about force majeure 16 months ago. What are you seeing right now on the issue?
Well, I think in a lot of ways, the force majeure issue has been addressed by a number of decisions that occurred during COVID already. I’m sure there’ll be more as we go. But there’s been enough of a body of case law, particularly in New York, that would indicate that it’s very contract-specific. And unless the contract really provides for relief based upon a pandemic or epidemic, that otherwise, tenants or other parties are not going to be relieved of their obligations based on standard force majeure language.
I do think people are now revisiting that language in ways that they never did before. I think that the force majeure language was always an uninteresting part of the contract negotiations, and all of a sudden it’s an important part of that discussion. But, in large part, what we’re seeing is that the standard force majeure clauses you’re seeing typically do not protect or relieve tenants, for example, of their obligations to pay rent unless there’s specific language relating to epidemics or pandemics. And we’re also starting to see those clauses being negotiated more specifically in negotiations as they go forward.
Let’s talk about the hotel space. Where do you think we are right now in the hotel cycle as it relates to the pandemic?
We’re in the reopening phase. We went through a phase where we were closing down hotels left and right, either temporarily or permanently, or being in a skeletal staff situation. Now, these hotels are in the process of reopening. And there are a number of issues that are being faced by operators and owners alike. As these hotels reopen, historically, you would have an operating hotel generating cash flow to operate the business. Those hotels are not doing that right now, or they haven’t been, and if they are now, they’re doing it at a much more minimal level. So there’s frequently going to be need for working capital if a hotel is going to open. So owners and operators have to get on the same page as to when and how they’re going to reopen their hotels, because that’s going to cost money. And there may be a difference of opinion there as to when it’s prudent to actually spend that time and money. Is it better to open now, or is it better to wait? That’s a big issue.
And number two is labor. There is not enough human capital right now out there in hotels around the country, quite frankly. And New York, as well. Because so many people were laid off, and you can’t snap your fingers and reengage a couple hundred employees at a large hotel. There are very serious service problems, and I’m sure the owners and brands alike are going to be struggling with that, and what that means for performance.
What about litigation in the hospitality space — how is it different or similar to the litigation you’re seeing in other sectors of real estate?
Well, I think two things. Number one, … there are a number of real estate finance … litigations out there right now, and I think you’re going to see more of that. And, secondarily, … we’re seeing an uptick in disputes between owners and managers as frustration mounts, whether properly or improperly, over performance. Now that we’re coming out of COVID and [properties are] requiring a lot of capital, and whether or not the brands are operating the way they should be and whether owners are contributing capital the way they should be, I think you’re seeing a lot of finger-pointing going on.
And what about disputes between hotel owners and lenders? What are you seeing there?
There’s definitely an uptick in that, where the lending community is seeing distressed hotels, is starting to take action to enforce their rights, and then the borrowers, the owners, are looking to either work their way out through some type of negotiation or to be recapitalized. Or otherwise the lenders are coming in — they’d be first mortgage lien holders or mezzanine lenders — to enforce their rights. We’re seeing that play out.
You mentioned private equity earlier. What’s your take on how PE firms have been involved in all of this?
Over the last 10 years, a number of private equity firms have set up significant lending platforms. And so currently you see a strong presence of the private equity firms in the real estate finance space. And so a lot of big foreclosure-oriented cases you’re hearing about now, whether it be mezzanine loan foreclosures, whether they be first mortgage lien foreclosures, it’s very common to see the private equity firms involved in that.
I do think there’s another aspect of that to the private equity firms. They have to always ask themselves: … do they have the capability of managing the assets they may acquire through a foreclosure? So, you are seeing instances of private equity firms not looking to do that but looking to … perhaps sell off their position, so they don’t have to be in a position to fully own the asset that they had originally loaned against. So there’s a different set of decisions that the private equity firms have to make, particularly when you foreclose.
How do you see the coming months playing out in terms of disputes between owners and lenders?
I expect to see more of it in the first instance. I think we’re only at the beginning of this. I do think you’re going to see more workouts. … Because of the presence of so much capital in the market, I think that provides opportunity and willingness for people to jump in and try to provide capital to take over projects, … including paying off debt or restructuring debt as they go forward. So I think you’re going to see a lot more foreclosure activity. And I think you’re going to see a lot more workouts. I don’t think you’re going see a bunch going all the way to the end. I also think you’re going to see guarantee litigations.
What do you mean by guarantee litigations?
A lot of these loans are either nonrecourse or there are recourse carveouts. … There’s always the possibility of more litigation over personal guarantees relating to these loans. And, with any uptick in litigation over foreclosure of any type, there’s a tendency to have greater likelihood of litigation over the applicability of personal guarantees.