Getting legal architecture right on luxury mixed-use

NATIONAL REPORT – With branded residences on the rise, luxury mixed-use hospitality projects that span from hotels to multiple residence types, golf, food and beverage outlets, and more, are surging. To keep these interconnected components both financeable and operationally sound, it is vital to design a legal structure in the early stages that is aligned with lender and hotel/residential brand needs from pre-development through post-opening. This article provides a step-by-step guide to do just that.

Create a site map

Most projects start on one parcel owned by one single purpose entity (SPE). That structure typically evolves as the project matures. As the project is developed, the land is often subdivided into components (e.g., hotel, residences, golf/club, beach clubs, common areas) and conveyed to separate SPEs. For residences, expect a condo or similar master association regime to handle governance, cost sharing, and common areas (i.e., the entity that controls and maintains shared facilities and amenities and pays common expenses).

Legal structuring matters because clean “boxes” make financing and management arrangements workable. In other words, the way you draw parcels and entities will show up in loan collateral descriptions, hotel/residential brand agreements, homeowners’ association (HOA) documents, and sales materials; think of each “box” as a future collateral package for a lender and a disclosure package for buyers. To assist in keeping a project financeable and avoiding restructuring down the line, prepare a site map identifying which entities are intended to own what components of the project early in the development planning and circulate it to counsel, lenders, and the hotel/residential brand company so all stakeholders are working from the same site map.

The way you draw parcels and entities will show up in loan collateral descriptions, hotel/residential brand agreements, homeowners’ association (HOA) documents, and sales materials; think of each “box” as a future collateral package for a lender and a disclosure package for buyers.

Define collateral - keep it clean, compartmentalized

When approaching the financing of the project, start with the foundational question: what exactly is the lender financing? In other words, what is the “collateral” (the assets pledged to secure the loan)? One lender may finance the whole project, but often different lenders finance different components (with other members of the capital stack filling in the gaps). The parcels and entities identified on the site map should align with the collateral and intended “borrowers” under the various financings.

Lenders expect clean separation of their collateral from all other elements of a project. Each lender wants an SPE that holds only collateral subject to the financing. If a lender finances only the hotel, that SPE should own only the hotel parcel and related personal property. The same principle applies to contracts and contractual liabilities: lenders want their borrowers’ contractual obligations to be limited to that lender’s collateral, and not extend to other elements of the project.

Specifically, lenders want collateral assignments (a lender’s right to step into its borrower’s contract if the owner defaults) of management/branding agreements that govern only their component of a project, and do not want their borrower to have any liabilities that relate to a different component of the project so that a problem with another component of the project doesn’t threaten their flag or step-in rights.

Similarly, lenders do not want their borrowers to have any obligations or liabilities relating to elements of the project other than their collateral. For example, in project with a hotel and golf club, the hotel SPE should sign the hotel management agreement and the golf club SPE should sign the golf club management agreement, and these SPEs should not have any liabilities or obligations relating to any other component of the project.

The parcels and entities identified on the site map should align with the collateral and intended 'borrowers' under the various financings.

Here are a few ways that you can set this up early and avoid costly re-structuring later in the project development:

Align on the structure of the financing before finalizing hotel/residential brand and management terms. If separate financings are likely (e.g., separate loans for the hotel and residential components of a project), ensure that agreements are component specific.
Insulate defaults and termination rights to the component at issue (e.g., a default by the golf SPE should not automatically terminate the hotel agreements).
Incorporate lender step-in language and foreclosure transfer mechanics into the first draft of the brand/management agreements, not at the last minute. Your closing timeline will benefit.

Establish quality control, coordination

Luxury brands want consistency across the project, which usually means a coordinated set of agreements covering pre-opening, hotel operations, HOA management, club operations, and residence sales and marketing. “Consistency” in this context means aligned design standards, service levels, marketing use of the brand, and guest/owner experience across components. Some agreements will be project-wide; others will be component-specific. For example, the typical suite of agreements for a luxury branded hotel and residential project includes the following:

A pre-opening/technical services agreement that addresses the pre-opening design and construction of the project as a whole, including pre-opening operations;
A hotel management agreement that addresses the management of the hotel after opening;
A hotel license agreement that governs the use of the brand’s name in the operation of the hotel after opening;
A residential sales and marketing license agreement that governs the use of the brand’s trademark in the sales and marketing process for the residences; and
A management agreement between the HOA for the project and the brand/management company providing for the management of the HOA after opening of the residential component of the project.

When negotiating these agreements, there are a few important scenarios to think through:

Retrofitting lender and brand and management protections at the end of a development is like adding an elevator after topping out—possible, but time-consuming and costly.

Cross-termination and cross-default. These can be helpful for brand integrity but risky if an issue in one component destabilizes the entire project. Oftentimes, elective cross-termination with materiality and cure standards is preferred over automatic triggers (i.e., allow termination only for serious issues, after notice and an opportunity to remedy).
Common ownership/control requirements (i.e., requiring that all components of the project be under common ownership and control). This requirement may conflict with a developer’s desire to finance elements of the project separately (because upon foreclosure of one of the financings, the foreclosed component of the project will be under separate ownership), potentially necessitating negotiation of which elements of a project may be sold or financed separate, and at what stage of the development process. The agreements should establish a clear transfer pathway (including lender transfers and post-foreclosure ownership) to avoid future deadlock.
Multiple residence types. If there are multiple types of residences or multiple residential components under a common brand, the hotel/residential brand company will require consistent marketing and brand standards. Any ownership fragmentation that occurs in a structure that permits separate ownership of individual residential components of a project could threaten this consistency. As a result, depending on the type of residences, the brand may require common ownership of all residences at all times. If the brand company permits separate ownership (whether throughout the development process or only after certain milestones have been met), covenants requiring consistent marketing and brand standards that survive any sales of separate components may mitigate this issue (e.g., branded condos, villas, stand-alone homes, and fractional interests should follow the same brand rules and have consistent messaging).
Agreements segmented by project component. If separate sales or financings of different components of a project are likely (and permitted by the hotel/residential brand company), create parallel, component-level agreements from the start. This approach is cleaner for defaults, lender step-in rights, and terminations while still preserving project-wide standards via master covenants and shared services, and avoids costly restructuring of agreements late in the development process.

Align credit support with reality

If the master developer SPE that owns the entire project development site signs all of the brand/management agreements at the outset of a project, that provides strong credit support for the developer obligations relative to the brand/management project, but, from the developer’s perspective, this construct restricts the ability to sell and finance components of the project separately for the reasons stated above.

Early in the process, developers should map parcels and SPEs to components, confirm how each piece will be financed, ensure all stakeholders are in alignment, and negotiate a thoughtful and flexible suite of brand and management agreements that preserves both brand integrity and protection and lender step-in rights.

If only the component SPEs sign the brand/management agreements, this flexibility is preserved, but the developer will need to assure the brand/management company that the assets of the individual component SPEs are sufficient to support the developer’s obligations.

This is an especially critical issue when dealing with residential projects, where the SPE that owns the residential development by design will not have any assets once the residences are sold to third-party buyers (thus leaving no credit support for any obligations under the residential agreements that may exist after sell-out, such as indemnity obligations).

A middle path is available: have component SPEs be the contracting parties, with targeted parent guarantees for defined obligations (e.g., pre-opening costs, completion, indemnities), supported where needed by escrows, bonds, or insurance. This keeps day-to-day obligations with the right entity while giving brands (and lenders) comfort on completion and indemnity risk. Clear sunset provisions and survival terms should be added so guarantees phase out as risks naturally decline.

Design: Deliberately predictable

The best projects are exciting for guests and predictable for lenders and brand/management companies. To achieve this goal, aim for:

Segregated ownership and collateral by component.
Compartmentalized, lender-friendly brand and management agreements, with targeted credit support without unnecessary collateral damage.
Cross-default/termination that protects standards.

Timing matters. Locking in the legal architecture before chasing financing and finalizing brand/management terms is far easier and more cost-effective than retrofitting them later. Retrofitting lender and brand and management protections at the end of a development is like adding an elevator after topping out—possible, but time-consuming and costly.

Takeaways

Structure, financing, and brand/management strategy for luxury mixed-use projects should be designed together, not in sequence.

Do this, and you’ll keep your options open for sales and financings, reduce closing friction, and deliver a project that feels seamless to guests and reassuringly uneventful to your lenders.

Contributed by Teresa Goebel and Jacob Boyer, Mayer Brown LLP, San Francisco

The views and opinions expressed in this content do not necessarily reflect the opinions of Hotel Investment Today by Northstar or Northstar Travel Group and its affiliated companies.

Getting legal architecture right on luxury mixed-use

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