The following is intended as a practical guide to owners considering whether and how to restructure a hotel property that can’t support or refinance its current debt.

In the current economic climate, most often the situation arises because the existing debt, which was incurred in 2006 or 2007, is coming due and can’t be refinanced at nearly the same levels as the current debt.

The inability to refinance the debt arises from a combination of circumstances: values have fallen, underwriting of debt-to-equity levels has become more conservative, and spreads have risen dramatically to compensate lenders for perceived risk.

Here are some guidelines for owners trying to restructure debt that is too onerous to pay or refinance:

1. Preserve enough liquidity for the task: The prerequisite to a successful restructuring is having enough liquidity (i.e., cash) to carry through the restructuring. Many owners don’t focus on restructuring issues until they’ve been drained of liquidity, in which case failure is preordained. You will need cash for the following purposes:

• Paydown of the debt: Assume a 10% to 15% paydown on the existing debt will be required to persuade the lender to extend.

• Pay your own and the lender’s professionals: You will need cash to pay retainers and current billings to your restructuring counsel, restructuring adviser (if you have one), appraiser (the lender, new or old, will want a new appraisal) and the lender’s lawyers and consultants. Restructuring professionals require a source of payment not contingent on the restructuring being successful.

• You also need cash to make the prospect of a bankruptcy filing credible to the lender.

2. Assess the legal and financial situation clearly and without illusions: On the legal front, the owner will need a careful review of the debt situation to assess the owner’s potential exposure. Among the common issues that must be examined:

• Is the debt recourse or non-recourse? If it’s non-recourse, is there a “bad-boy” guarantee that, if triggered, can convert the debt from non-recourse to recourse? Many financings have these bad-boy guarantees.

For example, if the sponsor of one hotel that is about to default on its debt has signed a bad-boy guarantee prohibiting the commencement of a bankruptcy case, voluntarily filing for bankruptcy may expose other assets of the sponsor to claims from the lender, thereby converting a non-recourse loan into a fully recourse loan.

• Has the owner posted collateral in addition to the property?

• Will a default under one loan document trigger a default under other loans that the sponsor has?

• If the owner has multiple partners, how easy is it to call new capital and dilute partners who don’t wish to participate in the new round of equity financing?

• Who controls the owning entity and what are the limitations on action by various constituents, such as the general partner?

On the economicfront, the owner needs to assess how much human and financial capital it wants to spend to preserve its ownership. It needs to assess the following:

• Can the property recover its previous value given today’s market and financial dynamics?

• What will the owner’s return be on the new capital it invests and does that investment return meet its hurdle rate for new investments?

• What will the tax effect be of various scenarios, such as foreclosure or forgiveness of indebtedness?

3. Assemble the team: A hotel owner will need to assemble a restructuring team, which should always include an experienced restructuring lawyer and a knowledgeable tax adviser. It may include a restructuring adviser who can be a conduit to the lender in structuring solutions.

The need for a restructuring adviser will depend in large part on the dynamics of the particular situation. The owner needs to spend enough time with the team so that the team and the owner can assemble a coherent and feasibleplan.

4. Prepare a feasible Plan A, but have ready a Plan B: The plan the owner proposes to the lender needs to be feasible, but aggressive. Restructuring plans are, however, more art than science.

For example, a plan that requires significant concessions from the lender but involves no paydown or additional capital injection from the owner is unlikely to be accepted by the lender.

On the other hand, it may well be feasible to suggest that the lender write off some of its loan in exchange for an additional capital injection, depending on the property’s value.

In composing Plan A, the owner needs to know and consider:

• How has this lender acted in similar restructurings (facts not easily discoverable)?

• Is there more than one lender in the credit and what has the owner’s experience been on inter-lender dynamics? (Lenders may have vastly different perspectives on how to deal with restructurings, depending on their particular capital issues, temperaments and desires to put bad news behind them. With multiple lenders, forging a compromise satisfactory to all can be a challenge.)

• Does the lender think that it is over or under-secured? An over-secured lender who believes that it can recover its investment by foreclosure is likely to be less cooperative than a lender who believes that it is under-secured and would like to wait for an upturn in the hotel markets.

• Does the owner need to raise additional equity capital? If so, how long is that process likely to take and what are the pre-requisites of the new capital?

Plan B is the disaster scenario, if the lender rejects Plan A. Every owner contemplating a restructuring must have a Plan B in case Plan A doesn’t work. Plan B can be a bankruptcy filing, handing the property back to the lender or a sale of the property, depending on circumstances.

Do the best to execute Plan A, understanding that restructurings are likely to be chaotic and unpredictable.

Present Plan A to the lender while making the point that the plan leaves the lender much better off than Plan B (whatever that is). Expect rejection, vituperation and a wailing and gnashing of teeth by the lender.

Try not to be confrontational with the lender; the objective is to keep talking, trying to convince the lender of the virtues of your restructuring plan. If all else fails, activate Plan B.

Phil Gordon is a partner in the hotels and leisure practice at the law firm Perkins Coie. Based in Chicago, he focuses on hotel transactions and management agreements and has supervised the acquisitions, financing and management agreement negotiations of more than 50 hotels in North America and Europe. He can be contacted at pgordon@perkinscoie.com.