INTER-CONTINENTAL WINS BATTLE BUT LOSES WAR; LOS ANGELES HOTEL REFLAGGED AS OMNI Sources: miscellaneous court filings in Inter-Continental Hotels Corp. v. California Hotel Acquisition Company L.L.C., et al., Case No. CV 99-03293 R (MANx) (C.D.Cal.) and Inter-Continental Hotels Corp. v. California Hotel Acquisition Company, L.L.C., et al., Case No. CV 99-11832 RAP (MANx) (C.D.Cal.)

Only months after Inter-Continental obtained a court order affirming its right to continue managing its downtown Los Angeles property, another judge of the same court has refused to prevent an Omni affiliate from raising the Omni flag. The hotel was acquired in 1997, shortly before Inter-Continental was acquired by Bass. The new owner then claimed that the presence of two nearby Holiday Inn and Holiday Inn Express properties constituted a breach of the territorial restriction in the management agreement. Inter-Continental sued, arguing that the Holiday Inn properties did not compete with the Inter-Continental.  The federal court not only agreed, but further went on to find that Inter-Continental had an irrevocable “agency coupled with an interest,” with the consequence that the new owner could not terminate the management agreement.

Unfortunately for Inter-Continental, that was not the end of the story. The new owner had financed its acquisition with a loan from Lehman Brothers, to which Inter-Continental had agreed to subordinate its management agreement. After the new owner lost the litigation described above, Lehman assigned its note package to an Omni affiliate, which provided new, additional financing. Within months, the owner defaulted and agreed to give the Omni affiliate a deed in lieu of foreclosure — and with it, the right under the subordination agreement to terminate the management contract.

Inter-Continental sued again, claiming that the loan assignment, new financing, subsequent default, and deed in lieu of foreclosure were a sham intended to disguise what was really a sale to Omni (which would not have been subordinated and which would have left Inter-Continental’s management agreement in place). A different judge of the same court, however, found that the owner was simply exercising its contractual rights, and refused to enjoin the owner from conveying the deed in lieu of foreclosure. The Omni flag went up on the property on May 5.

This has to be a highly disappointing outcome for Inter-Continental, particularly given its initial success. The first court ruling included potentially landmark victories on two highly significant points: that the presence of affiliated hotels might not violate a territorial restriction where the affiliated hotels do not compete with the subject hotel (a pressing issue for the Starwoods, Hiltons, and Basses of the world), and that Inter-Continental had an “agency coupled with an interest” that prevented the owner from terminating the management agreement at will. (It’s not clear whether in making the latter ruling the court was aware of the numerous cases holding that the contribution of a flag is not, by itself, sufficient to establish an agency coupled with an interest).  The second ruling rendered those victories moot. Worse, Inter-Continental had argued in its court papers that the Los Angeles property was a key element to its fledgling domestic system, because it enabled Inter-Continental to capture Pacific Rim visitors who might then stay at other Inter-Continental properties as they traveled across the country. If those arguments are correct, the loss of this property could deal a sharp blow to Inter-Continental’s ambitious domestic expansion plans. Ironically, those plans include the upcoming opening of a new Inter-Continental hotel in Cleveland — on the site of a demolished former Omni.

BANKRUPTCY

COURT REJECTS LESSOR’S ATTEMPT TO USE BANKRUPTCY AS TOOL TO BREAK UNFAVORABLE HOTEL LEASE Source: Dunes Hotel Assoc’s v. Hyatt Corp., 2000 U.S. Dist. LEXIS 2127 (D.S.C. February 18, 2000)

The Hyatt Regency in Hilton Head, South Carolina is owned by Dunes Hotel Associates, a partnership made up of various affiliates of the General Electric Pension Trust.  Hyatt operates the property under a long-term lease that expires at the end of 2016. In 1986, Dunes refinanced the hotel with a $50 million non-recourse loan from Aetna.  When the note matured in 1994, Dunes was unable to make its balloon payment, and Aetna instituted foreclosure proceedings. Dunes filed a Chapter 11 bankruptcy petition to stave off the foreclosure.

In the bankruptcy, the Pension Trust bought Aetna’s claim for $49 million, resolving the foreclosure issue. Dunes alleged, however, that the bankruptcy had been made necessary in the first place by an unfavorable Hyatt lease, which had prevented Dunes from selling or refinancing the hotel. Seizing upon a fortuitous technicality (the Hyatt lease had never been recorded), Dunes sought to “avoid” the lease under bankruptcy law — that is, to declare it null and void.  

After long and tortured proceedings, the federal bankruptcy court refused to set aside the lease, and a district court reviewing that decision has now agreed. Although the literal wording of the bankruptcy code supported Dunes’ argument, setting aside the lease would have frustrated the central purpose of the bankruptcy code: to protect creditors, not debtors. Because Dunes and its partners would be the only beneficiaries of that result, the court held that Dunes’ bankruptcy was properly dismissed, and the lease therefore remains in place.

Few lawyers (and fewer laymen) think that the purpose of bankruptcy it to protect creditors. Rather, most people understand bankruptcy as a way for overburdened debtors to escape at least some of their debts and to obtain a fresh start. As this case demonstrates, however, that result is just a side consequence of bankruptcy’s central purpose: to distribute a debtor’s limited assets among its creditors in a fair and equitable way. The fact that the assets will be insufficient to pay all of the creditors is taken as a given; the question is how to distribute those assets in a way that maximizes the recovery to each creditor and keeps any one creditor from receiving more than its fair share. As this case shows, a debtor’s attempt to use the bankruptcy laws to generate a windfall for itself, without any benefit to its creditors, should (in theory, at least) fail.

FRANCHISING

TWO COURTS, TWO VIEWS OF FRANCHISE TERMINATIONS Source: Days Inn of America, Inc. v. Patel, 2000 U.S. Dist. LEXIS 4503 (C.D.Ill. April 3, 2000); LaGuardia Assoc’s v. Holiday Hospitality Franchising, Inc., 2000 U.S. Dist. LEXIS 4494 (S.D.N.Y. April 6, 2000)

Two recent federal court decisions dramatically illustrate the two sides of the current debate over the relative bargaining positions in the franchisor/franchisee relationship. Although the two cases were decided within days of each other, they reflect diametrically opposite attitudes towards franchise terminations.

The first case concerned a Days Inn in Lincoln, Illinois.  After the property failed five consecutive quality assurance inspections over the course of two years, Days Inn terminated the franchise and sued for liquidated damages.  Taking a traditional approach, the court had no trouble finding that the franchisee had breached the agreement.  Although Days Inn waited until the fifth failed inspection before terminating the agreement, the court noted that the franchise agreement contained an explicit “no-waiver” provision. While the franchisee argued that the liquidated damages were excessive, the court pointed to provisions in the agreement acknowledging that actual damages would be difficult to calculate, that the liquidated damages were not punitive, and that the franchisee had the opportunity to seek advice before signing the agreement. The court therefore awarded $120,000 in liquidated damages, representing twelve years of lost franchise fee revenue.  

The second case, concerning two New York airport hotels, stands in stark contrast. For almost a decade, Holiday Inn had given the Holiday Inn at JFK and the Crowne Plaza at LaGuardia a two-month grace period for payment of their franchisee fees. In 1999 (possibly in connection with its acquisition by Bass), Holiday announced that there was “a new sheriff in town” and that the grace period would no longer be honored. Holiday declared the franchise agreements in default and demanded that the franchise fees be brought current. When the franchisees failed to do so over the course of the next ten months (despite several partial payments), Holiday removed them from the Holidex reservation system, and the franchisees sued to prevent the franchise from being terminated.

The case was heard by a respected federal judge (best-known for his leading treatise on federal evidence law). Surveying law review articles and treatises on the history of franchising, the judge quoted various passages referring to the “unequal economic power between the parties,” the way in which the “economic dominance of the franchisor may be brought to bear at the outset of the relationship to create a franchise contract that is unfair to the franchisee,” and the way in which a franchisor can purportedly “capitalize and exploit the local goodwill generated by the franchisee” by terminating an agreement prematurely. Given that introduction, the outcome was hardly surprising: despite a “no-waiver” clause virtually identical to the one in the Illinois case, the court held that Holiday had “permitted [the franchisees] to become addicted to payment delays,” and therefore “could not simply cut them off cold turkey.” The court held that Holiday could not terminate the agreements, but set up a payment schedule under which the franchisees would become current within the next 45 days, after which all payments would have to be current and made by wire transfer — a requirement that, “while not in the Agreements, is a reasonable quid pro quo for this injunction.”

The cases are not as irreconcilable as they seem at first blush.  Because the New York case concerned an injunction, the judge had considerably more leeway to do what he thought was fair under the circumstances than the Illinois judge, who was largely bound by the terms of the written contract. Likewise, by declaring a new default with each failed inspection, Days Inn helped prevent the kind of waiver that the New York court found when Holiday gave its franchisee ten months to bring its payments current after the default was declared. Nonetheless, the different approaches in the two cases are unmistakable, and you can be sure that you’ll see franchisors citing the Illinois case and franchisees citing the New York one in future franchise termination disputes.  

A side note: the New York case also featured a significant contract interpretation point. When the franchise agreements were drafted in 1990, Holiday was based in Memphis, and the agreements therefore provided that they would be governed by Tennessee law.  By 1999, Holiday had moved to Atlanta. The court held that because the franchise agreements no longer had any connection with Tennessee, there was no longer any basis on which to apply Tennessee law. The judge therefore considered himself free to apply New York law, which he apparently considered more franchisee-friendly.  Thus, at least according to this judge, a choice-of-law provision can be perfectly valid when a contract is entered into, but become invalid as circumstances change over the life of the contract.  The court didn’t cite any authority for that novel proposition, and it remains to be seen whether any other courts will follow.

SECURITIES

HOST MARRIOTT AND MARRIOTT INTERNATIONAL SETTLE TEXAS LIMITED PARTNERSHIP LITIGATION, WHILE HOST SCORES VICTORY IN DELAWARE DISPUTE Sources: In re Marriott Hotel Properties II Limited Partnership Unitholders Litigation, 2000 Del.  Ch. LEXIS 17 (January 24, 2000); “Marriott International and Host Marriott Tentatively Agree to Resolve Litigation Involving Hotel Partnerships by Acquisition of Partnerships Owning 120 Hotels,” PR Newswire (February 24, 2000); “Marriott International Signs Definitive Agreement to Settle Limited Partnership Litigation, Will Take One-Time $39 Million Charge in 1999,” PR Newswire (March 10, 2000)

Host Marriott and Marriott International made substantial progress on two fronts this quarter in litigation involving disputes over limited partnerships in which they were participants. In one class action pending against Host in Delaware, former limited partners had accused Host of making a tender offer which, Host purportedly represented, was the only way that the limited partners could achieve a sizeable short-term return. The limited partners alleged that Host then bought them out and began making greatly increased cash distributions. The Delaware court rejected a panoply of claims by the former limited partners, but did allow the case to proceed on the limited issue of whether the cash flow projections given in connection with the tender offer were false and misleading.

Shortly after the Delaware decision, Host and Marriott International announced that they had settled unrelated limited partnership litigation in Texas. Under the settlement agreement, Host and Marriott International will pay $372 million to acquire all of the limited partners’ interests in two limited partnerships which jointly own 120 Courtyard properties. The limited partners in several other limited partnerships will receive $31 million to resolve litigation over those partnerships.

Ever since Host Marriott and Marriott International were formed in the split of the former Marriott Corporation in 1995, various limited partnership lawsuits have been a thorn in both of their sides. After years of wrangling, it now appears that those litigations are on their way to finally being put to rest.

SETTLEMENTS

ADAM’S MARK, RADISSON SETTLE SUITS Sources: “Justice Department Settles Lawsuit Against The Adam’s Mark Hotel Chain,” United States Department of Justice Press Release No. 00-134, available at www.usdoj.gov/opa/pr/2000/March/134cr.htm; “Radisson Has Settled Empire Hotels’ Lawsuit,” Hotel Business, p. 3 (March 7-20, 2000)

Two lawsuits that we reported in past issues have now settled. First, Adam’s Mark has brought a swift conclusion to the civil rights lawsuit that we reported in our Winter 2000 issue. Under the terms of the settlement, Adam’s Mark will hire an outside monitor to investigate guest complaints, monitor diversity and nondiscrimination training programs, and establish a marketing plan directed at African American markets. Adam’s Mark will also pay $4.4 million to the members of the class action brought against it, as well as $1.5 million to the State of Florida to distribute to four historically black Florida colleges.

Second, Radisson and Ian Schrager’s Empire Hotels have settled the lawsuit reported in our Spring 1999 issue, in which Empire alleged that Radisson overstated the reservations delivered to the hotel. Radisson had accused Empire of using the issue as a pretext to terminate its license agreement without penalty, and based on the limited public information available, it looks as though Radisson may have gotten the better of the settlement. Empire agreed to pay “a substantial termination fee,” and an Empire executive was quoted as saying that he “would certainly consider using the Radisson reservations system in the future if the opportunity arose.”

One of the difficulties in tracking hotel litigation trends is that while it’s easy to file a lawsuit, it’s harder to win one. Put another way, the fact that a lawsuit is filed, by itself, doesn’t tell you much about the merits of the case. Most cases settle, and most settlements are confidential (either as a requirement of the settlement agreement or, as a practical matter, because neither of the parties is interested in publicizing the outcome). Where one of the parties is a public entity, such as the Justice Department in the Adam’s Mark case, the chances of a publicized settlement are far greater; indeed, the Justice Department regularly places relevant press releases and settlement documents on its web site. In purely private litigation, however, publicized settlements are quite rare — making both the Radisson and Marriott settlements all the more unusual.

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