BASS SETTLES WITH JUSTICE DEPARTMENT; WILL REVAMP CRS, ESTABLISH NATIONWIDE MEDIATION PROGRAM Source: “Holiday Inn Hotels to Establish Nationwide Mediation Program Under Agreement Reached with Justice Department,” United States Department of Justice Press Release No. 98-592, available atwww.usdoj.gov/opa/pr/1998/December

Bass Hotels & Resorts has entered into a settlement agreement with the U.S.  Department of Justice under the Americans with Disabilities Act, under which Bass will allow disabled travelers to reserve accessible rooms through its central reservations system. Bass also agreed to set up a nationwide mediation program to resolve ADA complaints regarding any of the nearly 2000 domestic Holiday Inns, Crowne Plazas, and Staybridge Suites owned, licensed, or franchised by Bass. Nineteen individual franchisees also agreed to modify their hotels to come into ADA compliance.

For many years, primitive CRS technology would have prevented this type of settlement from ever happening. In addition to the problems posed by trying to use computer systems originally designed for booking airline tickets to instead book hotel rooms, the incompatibilities between central reservations systems and property management systems made it virtually impossible to reserve a particular room through a CRS. As the sophistication of central reservations systems grows by leaps and bounds with each technological advance, reserving an accessible room has become a possibility. That’s good news and bad news, of course; the more prevalent these new capabilities become, the easier it will be for the government (or private plaintiffs) to argue that such measures are required as “reasonable” accommodations under the ADA. Stay tuned.

MANAGEMENT CONTRACTS

“NOTICE AND CURE” UNNECESSARY WHEN MANAGER ENGAGES IN SELF-DEALING
Source: Larken, Inc. v. Larken Iowa City L.P., 1998 Iowa Sup. LEXIS 290 (Iowa December 23, 1998)

Many management contracts contain “notice-and-cure” provisions — requirements that before one party can sue the other for breach of contract, it must give the breaching party written notice and the opportunity to cure the breach within a specified period of time. When the manager is accused of self-dealing, does an owner have to comply with such a provision before terminating the management agreement? Not according to the Iowa Supreme Court.

The case involved a suit by an owner against the manager of a Holiday Inn in Iowa City. The owner sent a letter to the manager, accusing the manager of engaging in self-dealing, claiming a default under the management agreement, and stating that the owner intended to terminate the agreement.  The manager then filed suit, asking the court to declare that the manager had not breached the management agreement and that, in any event, the owner could not terminate the agreement without giving the manager the opportunity to cure the alleged breach. The court found that the manager’s self-dealing constituted a breach of the agreement, and on appeal the state supreme court ruled that by engaging in self-dealing, the manager lost the right to cure the breach.

“The acts of self-dealing… were so serious that theyfrustrated one of the principal purposes of the management agreement, which was to manage the hotel in the best interests of the owner and to be forthright in its dealings,” the court stated. Because “merely requiring [the manager] to retroactively undo its wrongdoings” would not be an“adequate remedy,” the court held that the contract could be terminated without giving the contractual notice and opportunity to cure.

The case caps a busy fall in the courts for this particular manager. See LeBlanc v. Cahill, 153 F.3d 134 (4th Cir. August 11, 1998) (discussed in our last issue); Larken Management, Inc. v. SMWNPF Holdings, Inc., 1998 U.S. App. LEXIS 30493 (4th Cir. November 30, 1998).

The case is notable in at least two respects. First, a companion case between the same owner and the same operator, concerning a Hilton Inn in Bloomington, Minnesota, had come to the opposite result. In that case, a state trial court applying Minnesota law decided that because the purpose of a management agreement is to make money, any breaches were “immaterial” so long as the hotel was profitable, and the agreement could not be terminated without notice and opportunity to cure. The Iowa Supreme Court, applying Iowa state law, specifically rejected that reasoning.  The other notable aspect of this case is the nature of the self-dealing.  The trial court found that the manager breached the agreement by, among other things, appropriating rebates for its own purposes and entering into a telephone maintenance contract with an undisclosed related entity. (The court also found that individual employees had used rebates for personal purposes, as well as purchasing appliances, supplies, and services for their personal use).  How a manager (or a franchiser) uses rebates is a hot topic these days; if your management contract does not already specifically address items such as rebates and transactions with related entities (and many older contracts do not), you might consider raising the issue before it becomes a reason for litigation.

SECURITIES

PATRIOT AMERICAN FACING SHAREHOLDER LAWSUIT OVER RECAPITALIZATION PLAN Sources: “Class Action Lawsuit Challenging Certain Material Transactions Proposed By Patriot American Hospitality, Inc.,” Business Wire, January 14, 1999; “Patriot To Sell 30% Stake for Cash Infusion; $1 Billion To Be Used To Pay Off Lenders,” The Dallas Morning News, Business Section, Page 1D (December 17, 1998)

Patriot American’s recapitalization plan has prompted a lawsuit from its shareholders, according to a press release issued by the shareholders’ attorneys. Patriot’s plan to raise $1 billion in cash from Apollo Real Estate Advisors, Beacon Capital Partners, Thomas H. Lee Co., and Rosen Consulting Group in exchange for a 30% stake in the company was widely reported after its announcement in mid-December.  The subsequent lawsuit, filed in January in Delaware state court, asserts that Patriot “effectively” sold the company, and charges Patriot’s board of directors with breaching their fiduciary duties by agreeing to the transaction after incur-ring massive debt obligations under “forward equity contracts.” It also charges the acquiring group with aiding and abetting the breach.

As this issue goes to press, Patriot is considering competing offers from the Apollo group and Hilton under which, according to published reports, it may abandon its REIT structure altogether.  Having seen its stock price plummet from over $30 a share to under $6 in the past year, Patriot was faced with almost $1.7 billion in short-term debt and no way to pay it. Forced to choose between recapitalization, refinancing the debt with the lenders, or filing for bankruptcy, Patriot initially chose the Apollo transaction and its recapitalization with private money. Whether Patriot now chooses to stay with the Apollo offer or instead go with Hilton, and what effect its choice will have on the pending lawsuit, may be answered by the time you read this newsletter.

GROUND LEASES

“GOLD CLAUSE” NOT REVIVED WHEN GROUND LEASE FORECLOSED UPON AND ASSIGNED Source: Grand Avenue Partners, L.P. v. Goodan, 160 F.3d 580 (9th Cir. November 18, 1998)

Imagine buying a hotel and finding that due to an arcane legal technicality, the rent under your ground lease was going up by about 2100 percent. That’s the position in which the owner of the storied Checkers Hotel in Los Angeles found itself after buying the hotel from a foreclosing lender in 1994. Fortunately for the buyers, and not so fortunately for the ground lessors, one arcane technicality trumped another, and the rent stayed as it was.

Once upon a time, a common way to index long-term ground rent to inflation was to tie the rent to the price of gold. That all changed in 1933, when Congress banned the private ownership of gold and in so doing made “gold clauses” unenforceable — effectively freezing ground rent for decades at unadjusted levels. When the ban was repealed in 1977, gold clauses once again became enforceable, but only for contracts entered into after that date.

Ground lessors who were continuing to receive current rent in pre-Depression dollars therefore began looking for ways to transform these old, long-term ground leases into “new”
contracts and to thereby revive the gold clauses. Enterprising lawyers found their answer in an obscure legal doctrine: if a lease (or any other contract) is assigned to a new tenant,
and the old tenant is completely relieved of any obligation under the lease, it constitutes a “novation” — that is, a new contract between the landlord and the new tenant. Several
courts held that if a ground lease with a gold clause was assigned after 1977, with the old lessee relieved of any obligation under the lease, a novation occurred and the gold clause became enforceable.

Pointing to these cases, the ground lessor of the Checkers property claimed that when Sumitomo Bank foreclosed on the leasehold interest and then sold it to a new owner in 1994, the gold clause in the 1926 ground lease was revived and the rent increased from $2,000 a month to approximately $42,000 a month. Their claim, however, ran into yet another obscure legal doctrine: under California law in 1926, when a contract was assigned, the assignor arguably remained liable as a surety (unless the contract provided otherwise). The ground lease, however, provided that an assignment only released the lessee from “direct” liability —which the court interpreted as meaning that the parties wanted the assignor to remain liable as a surety. The old lessee therefore wasn’t completely freed of its obligations; the assignment therefore didn’t constitute a new contract; the gold clause remained unenforceable; and the ground rent will stay at $2,000 a month until the lease expires on December 31, 2025.

Gold clauses are a legal minefield, and the law, needless to say, isn’t exactly intuitive. The federal statute governing the enforceability of gold clauses has been amended twice in just the last three years. Moreover, what constitutes a “novation” can change from state to state and era to era. The lesson: if you’re thinking of acquiring a contract with a gold clause, proceed with caution. There are plenty of ways to avoid the problem; after the above dispute arose, for example, the lender and the buyer attempted to rescind the assignment and instead enter into a sublease, which (because it did not involve an assignment) arguably would have done the trick.  (Because the court found that there was not a novation even if the contract was assigned outright, it did not address the issue of whether a sublease would have left the gold clause unenforceable.) Just make sure you’re familiar with both the current status of the federal legislation and the sometimes obscure contract law of the governing state.

JURISDICTION

ACCEPTING INTERNET RESERVATIONS DOES NOT SUBJECT HOTEL TO SUIT IN STATE WHERE GUEST RESIDES Source: Romero v. Holiday Inn, Utrecht, 1998 U.S. Dist. LEXIS 19997 (E.D. Pa. December 15, 1998)

One of the obvious benefits of brand affiliation (whether through franchise, license, management agreement, or otherwise) is the tremendous access to potential guests.
Advertising, directories, toll-free central reservations, internet sites and booking engines, and a host of other benefits help local properties reach potential customers in remote cities, states, and even countries.

In our last issue, we discussed some of the issues involved in “jurisdiction” — when a plaintiff can require a defendant to come to a remote state to defend itself in a lawsuit. There, we focused on franchisor/franchisee disputes. A much more common problem, however, is when a hotel guest wants to sue a hotel in the guest’s home state. Often, a guest will argue that by soliciting the guest’s business in a remote state, a hotel subjects itself to the courts of that state. A recent variation of this argument is that a hotel subjects itself to suits in remote states by advertising on the internet, and in particular by taking reservations on the web. Given the web’s worldwide reach, that can lead to drastic results; in this case, for example, a plaintiff sought to sue a Dutch franchisee of Bass European Holdings in a federal court in Pennsylvania.  The court, though, refused to allow the suit. It is already well-settled that listing a hotel in a company directory, or taking reservations through a toll-free reservation system, does not by itself subject a hotel to the courts of a guest’s state. The court reasoned that internet reservations are simply an electronic equivalent of an 800 number, and that a hotel can therefore take reservations through its web page without subjecting itself to lawsuits anywhere in the country.

Generally, a company can be sued in a state if the company “purposefully avails itself of the privilege of conducting business” in that state, and thereby “invokes the benefits and protections of its laws.” As the internet has allowed small, “mom & pop” vendors to sell goods throughout the country (and the world), this has become a hot issue in the legal world, as courts try to protect consumers who purchase goods from vendors located in far-away states (or even offshore). Hotels, though, don’t ship goods to consumers; rather, the consumers come to them, and the argument that a consumer can only sue the hotel in the state where the hotel is located is therefore much stronger. There are, though, gray areas: what if a hotel sells amenities over the internet? Or what if a hotel targets the citizens of a specific state, such as through targeted sales or promotions? In such instances, a court might find that the hotel had “purposefully availed itself ” of the “privilege” of conducting business in the state, and therefore subjected itself to a lawsuit within the state.

ANTITRUST

MIRAGE ALLOWED TO PROCEED WITH CLAIM THAT TRUMP AND HILTON CONSPIRED TO BLOCK ATLANTIC CITY PROJECT Source: Mirage Resorts, Inc. v. Trump, 1998 U.S. Dist. LEXIS 19896 (S.D.N.Y. December 22, 1998)

A federal court in New York has allowed Mirage Resorts to proceed with a lawsuit in which it claims that Donald Trump and Hilton Hotels illegally attempted to impede Mirage’s development of a new property in the Marina District of Atlantic City. According to Mirage, Trump and Hilton conspired to block the development by, among other things, filing baseless lawsuits, illegally funding the campaign of a senator who opposed the funding mechanism for the project, and hiring away a former vice president of a Mirage subsidiary and using confidential information from that employee to defeat the project. Trump and Hilton at-tempted to have the case thrown out at its inception, arguing that even if Mirage’s allegations were true, they would not constitute illegal actions. The court disagreed, and the lawsuit will now proceed.

In asking the court to throw out the case, Trump and Hilton argued that a company cannot violate the antitrust laws by exercising constitutionally-protected political rights (primarily, the right to petition the government and the right of free speech). Under that well - established legal doctrine, a competitor can throw obstacles in front of a development by, for example, filing lawsuits, raising regulatory hurdles, or seeking adverse legislation — even if the competitor’s sole motivation is to stifle competition — so long as it has some legitimate legal basis for its positions. Although it won this round, therefore, Mirage will now have to prove that the lawsuits filed by Trump and Hilton were nothing but a sham —that is, that no one could realistically have expected the suits to succeed, and that Trump and Hilton filed them in order to interfere with Mirage’s business.

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