While the national economic outlook has seemingly begun to improve, the ongoing effects of the extended recessionary cycle continue to make an impact that is rippling through the hospitality industry. With a spike in loan defaults and continued rise in foreclosures, the hospitality industry is now at the forefront of this national crisis.

More than 12 percent of U.S. hotels are currently in default, and ominous predictions from industry analysts indicate that figure may even double by the end of the year. While many owners have taken extraordinary measures to avoid foreclosure by cutting costs, delaying needed maintenance or deferring property improvements, some loan defaults in a challenging economic climate are inevitable.

While foreclosure may be unavoidable in some cases, how the lender or management company subsequently handles the property and builds a productive relationship with the hotel franchise can have a direct impact on whether or not that hotel is able to keep operating successfully, and help maintain the value of the asset for resale. Keeping hotel franchise companies happy during times of turmoil can be critically important to a hotel's short- and long-term operational success, and there are a number of ways to maintain franchise agreements in the event of an ownership transition or default.

There are several general priorities and specific steps that lenders and management companies can take to establish a positive relationship with the franchisor and ensure that the value of the hotel is maximized:

APPRECIATE FRANCHISE VALUE
It’s important for lenders to avoid the all-too-common mistake of underestimating or not fully appreciating the true value of the franchise. Lenders who are too cavalier about the significant assets that franchise support brings to the table—both in terms of material and brand recognition—risk losing what can be a critically important component of both short-term successful recovery and long-term sustained profitability. The bottom line is most franchises contribute significantly to the value of a hotel, and it is measurably harder to operate, succeed and ultimately sell a hotel property that has lost its franchise flag.

PLAN AHEAD
Every responsible lender should have a comfort letter on file from the franchisor that stipulates that in the event of an owner default, the lender will be given the opportunity to fulfill the obligations under the existing franchise agreement and the franchisor will not terminate the franchise agreement as long as those obligations are met. A well-drafted comfort letter is a critical component of a smooth transition of the franchise agreement, and can eliminate many of problems associated with the lender taking control of a franchised property.

Essentially a pre-agreement of cooperation and understanding, a comfort letter outlines the framework of the new relationship between lender and franchisor, recognizing the lender under the franchise agreement and addressing any issues, which may arise as a result of an ownership change. While franchisors will generally look to protect their interests during a transfer in ownership, perhaps even charging an application or transfer fee, a comfort letter is an implicit acknowledgment on the part of the lender that the franchise flag is a valuable asset and is an important tool that can be used to preserve the brand value of the hotel.

UNDERSTAND YOUR POSITION
It’s vital that lenders take the initiative with their counsel to fully understand the terms and conditions of the franchise agreement before they move forward with a plan for managing or selling a hotel property. Franchise agreements can differ significantly both in structural and procedural terms; some franchise agreements may contain a clause stating that a foreclosure automatically triggers a franchise agreement default.

Different defaults have different cure periods, and a failure to resolve a default within the contractually determined time period may result in measures from the franchisor that can seriously impact the day-to-day operations of the hotel. A franchisor may respond to a default by disconnecting a hotel's reservations system from the regional or national network, removing signage and other significant steps that can have immediate and serious ramifications for the hotel's operational capabilities, marketability and profit margin.

Understanding the terms of an existing franchise agreement and working proactively to avoid drastic measures in the event of a potential default is not just sensible; it can be critically important.

WORK TOGETHER
It’s important to remember that brands also look at each hotel in the event of a loan default to determine how important that property is to the brand, and to evaluate whether it makes sense to keep the hotel in the system. All parties involved in the takeover, management and disposition of underperforming hotel assets will likely find it in their best interests to work together as much as possible.

Companies that have an established history with the brand can be invaluable assets. Every brand has its own set of specific operating standards, and partnering with an experienced team that understands how to meet those standards and efficiently fulfill franchisor expectations is a great way to keep lines of communication open and to reassure the franchise company that their needs are being addressed.

COMMUNICATE CLEARLY
Perhaps the most important element of maintaining a positive, productive and mutually beneficial relationship between owners and franchisors is communication. Prioritizing clear and consistent communication is the best way to avoid costly delays and misunderstandings and convey mutual expectations and obligations. If the franchise agreement requires a Property Improvement, for example, close and collaborative negotiation can help establish reasonable expectations for setting and meeting realistic goals under such a plan.

Communicating early and often in the event of a default or transfer in ownership helps to establish a good working relationship with the franchisor; a vital first step that can pay long-term dividends. All too often, the franchise status is an afterthought, and termination of the franchise agreement is well underway by the time contact is made between the lender or management company and the franchisor.

With the hospitality industry anticipating a challenging economic landscape going forward, the ability to work closely with hotel franchise companies will continue to be an important issue within the industry. The challenges and rewards of maintaining a franchise agreement during a difficult economy will feature prominently as the industry works toward a brighter future in the years ahead.

Robert Habeeb is president and COO of Rosemont, IL-based First Hospitality Group. He can be reached at rhabeeb@fhginc.com or 847.299.9040.