The COVID-19 pandemic raises many legal questions

As hoteliers weigh their options for avoiding debt as business drops to nothing, an attorney offers saving advice

Rahul Patel, managing partner and the Patel|Gaines law firm in San Antonio, Texas, advises his clients on Texas property tax law, the application of “force majeure” clauses and other legal issues generated by the COVID-19 pandemic.

THERE ARE MANY challenges for hotels operating under the COVID-19 pandemic and its ensuing travel restrictions. It is a unique situation and, therefore, one that presents unique legal problems for hospitality businesses.

It may be advisable to have an attorney available to avoid or resolve issues that may otherwise produce costly results.

The Patel|Gaines law firm in San Antonio, Texas, has a page on its website dedicated to COVID-19 legal issues, and Rahul Patel, managing partner, has been taking on cases stemming from the pandemic. The main topics include property taxes, the application of “force majeure” clauses to escape contractual obligations and relief from commercial mortgage backed securities loans.

The tax man will cometh

Property taxes are, and the possibility of relief from them, are important subjects for Patel’s clients. In a March 27 property tax podcast he conducted with the firm’s Senior Associate Attorney Kathlyn Hufstetler on the tax situation in Texas, the question was raised about whether this year’s taxes would be collected.

There are a lot of discussions being held about 2020 property taxes, Patel said. For one thing, all property tax values for 2020 listed in the state’s plan are dated as of Jan. 31.

“As of Jan. 31, most businesses were not impacted by the coronavirus or COVID-19, so therefore you would not really see a lot of impact negatively or downward assessment on your 2020 taxes,” he said. “However, lots of counties are taking this into consideration and know that you will have a problem paying your taxes when they become due later in the year or Jan. 31, 2021.”

It’s still too early to say what solutions are out there yet, but they are monitoring the situation, Patel said.

“More will be known as time passes what will happen for 2020,” he said.

Of course, Patel said, property tax laws are different from state to state.

“I do think a lot of commonalities will apply when it comes to property tax and different tax-related issues in that we’re doing everything we can as a country to pump dollars back to business owners, but at some point it’s going to come from somewhere, right?” he said. “We know that, and it’s going to come in the form of taxes at some point, whether that’s income taxes, sales tax, property taxes, occupancy taxes, whatever you call it it’s going to come back.”

Hotels should be aware of that so they can mitigate the impact on their bottom lines.

“I see state sales tax across the country probably starting to increase. I think property taxes will probably start to increase as well,” he said.

Acts of God

Another possible source of relief, but one with possible legal complications, is the “force majeure” clause found in most contracts. The clauses, also known as “Act of God” clauses, essentially state that certain unforeseen events or circumstances can occur that are beyond control and may excuse or suspend a party’s obligations under the specific contract, according the Patel|Gaines website.

“They call them an ‘Act of God’ provision because it’s for something that was out of the breaching party’s control,” Patel said. “But is the pandemic an act of God? Would that negate my requirements to fulfill my contracts?”

The force majeure clause can include specific legal procedures for invoking its protection, including providing notice that it has occurred, spelling out how it might affect performance and taking steps to mitigate that impact. But actually implementing the clause encompasses accounting for many different circumstances that may or may not be spelled out.

“Let’s say you have a hotel with a big banquet hall and you had agreed to do a wedding. What if they still wanted to do the wedding and you’re not able to do it?” Patel said. “What if you’re not able to provide the food and services necessary. What if you and the other party don’t want to do it and they’re asking for a refund and you’re telling them it’s a credit?”

In other cases, he said, many hotels have leasing agreements with restaurant owners that they can no longer honor because the hotel is closed.

“Those are the types of things where force majeure is starting to come up. A lot of people are having questions about it,” he said “Generally I call it a ‘It depends’ legal argument, but it truly does depend on how it’s crafted and what the situation it’s being brought up in.”

Furthermore, nobody alive has lived through a major pandemic like this, he said.

“When was the last time something like this has come up? I think that’s where a lot of litigation will stem from,” Patel said. “I see, more or less, right now people trying to find ways to better their business situation regardless of what side they’re on.”

Business interruption coverage may not come through

Some hotel owners may be planning to cash in on business interruption insurance policies. Don’t count on it, Patel said.

“I think that there are probably some strong legal provisions that state that your insurance should or does cover this type of situation. But the flip side to that is, whether it says that or not, or whether it’s covered or not, isn’t really the situation. The situation is how long is it going to take for you to find relief under that?” he said. “Do you believe that insurance companies are going to bend over and say ‘Hey, $20,000, let’s just pay the claim.’ No, because there’s going to be thousands of claims. I told someone that it might not be a bad angle to pursue, but if you’re relying on that to come in next month then you’ve got a problem.”

Actually getting paid by the insurance companies will probably take five years and legislative as well as legal action, he said.

“You better rest assured that the insurance company lobbying arm is bigger than most, so you can expect them to argue and lobby pretty hard that business interruption doesn’t apply to a national pandemic such as this,” Patel said.

More complicated than you think

The firm’s website also contains a checklist of documents a hotel may need to seek relief from commercial mortgage backed securities loan. However, CMBS loans are more complicated than regular loans, as discussed in a recent AAHOA webinar featuring Peter Berk, president of PMZ Realty Capital LLC Hotel Finance Group.

“CMBS is going to be more of a challenge right now. You have to work through servicers, you have to work through special servicers. It’s not like your local bank,” Patel said. “When there’s a downturn in the economy, people are not going to be ready for what will happen because they haven’t really understood CMBS loans.”

Patel wrote an article in 2018 on the potential for problems with the CMBS loan market. One issue was the highly structured cash management process that comes with a CMBS loan that may not appear to be a problem while the economy is good and the hotel owner can make their payments.

“But if the hotel suffers a downturn, the lender essentially takes control of cash flow until it returns to pre-set levels. In short, the CMBS borrower gives up a lot of control over the property’s finances,” Patel wrote.

And a CMBS borrower can be considered in default even if they are making their monthly payment if their debt service coverage ratio drops too low.

“Certainly, we’ve all seen what can happen when excessive optimism mixes with excessive leverage,” he wrote.

At the end of the article, Patel concluded that hoteliers consider “funding channels that are more suited to the world of 2018” when the threats to the industry came from over supply and OTAs. In the world of the current pandemic, many may wish they had heeded that advice.

“Many of the lodging folks haven’t really understood how CMBS loans are structured, they just believe it’s a normal loan,” he said. “They’re not a normal loan. [Some hoteliers are] not ready for this.”