Surviving the Pandemic: Stress and Distress in the Hospitality Industry

22 July 2020 Coronavirus Resource Center:Back to Business Blog
Authors: Richard J. Bernard Thomas Charles Scannell

The coronavirus outbreak has impacted the hospitality industry disproportionally more than other industries. For many companies, revenues have fallen off the cliff. Further, the uncertainty and likely overhang of disruption caused by pandemic in the hospitality industry will continue for the foreseeable future.

Revised projections show a worsening impact of the coronavirus on the U.S. economy, including a loss of 8 million jobs in the hospitality sector by the end of April due to declining travel. Millions more jobs in the hospitality sector could also either be lost or severely impacted by the outbreak. In late March 2020, the American Hotel and Lodging Association said 45% of all hotel jobs had been or would be eliminated in the next few weeks. Current forecasts of a 30% drop in hotel occupancy over a full year would result in the loss of nearly 4 million hotel jobs, ranging from general managers to housekeepers.

The restaurant industry faces major upheaval as a result of the pandemic, as the Centers for Disease Control and Prevention has recommended avoiding groups of more than 50, and many cities and states have ordered restaurants to offer only takeout service. Even as cities and states reopen for business, they will limit restaurant capacity.

Shares of three major cruise companies—Royal Caribbean, Carnival Corp., and Norwegian Cruise Line Holdings—dropped more than 50% in the wake of the coronavirus pandemic.

To weather the coronavirus storm, companies in the hospitality industry should consider the following.

Conserve Cash

With seriously reduced or no revenues, companies in the hospitality industry need to find ways to conserve cash. This includes analyzing essential spending; idling operations; working with vendors, landlords, and suppliers regarding credit terms; and applying other methods. To maximize their liquidity position, hospitality companies must prioritize their use of cash.

Hospitality companies should consider the relative costs and revenues of idling operations—i.e., temporarily closing locations—until business is permitted or activity normalizes. For example, many governmental entities have prohibited restaurants from providing dine-in service but permit them to fulfill takeout orders. However, restaurants need to consider the cost and benefits, and overall results to cash flow of remaining open for takeout service. Hospitality companies will continue to have some cash burn to idle operations, but the net cash burn at idle may be less than that incurred in maintaining skeletal staffs to provide takeout service.

Good relations with its trade creditors might enable a company to establish a standstill on “old” payables until hospitality companies can restart or normalize operations. In the event hospitality companies require some goods or services on a limited or one-off basis, arrangements may be made for c.o.d. or to source those needs with an alternative vendor.

Hospitality companies may have similar negotiations with landlords, and they should also review leases and contracts for applicability of force majeure provisions or other legal rights/excuses regarding performance. Until these landlord and contract issues are resolved, hospitality companies must consider deferring rent and contract payments at this time, especially where they are not receiving benefits or services provided under such leases and contracts.

Lack of liquidity reduces the runway and range of options for financially stressed or distressed hospitality companies. With the indeterminate length of disruption resulting from the coronavirus, cash provides additional time, which may be necessary for survival until the industry normalizes and opportunities return as this crisis runs its course. Although the federal government has passed stimulus and bailout laws and allocated funds that may assist hospitality companies, it remains unclear if and when companies will receive such funds. However, these stimulus dollars are not expected to make companies whole for their losses due to the crisis.

Communicate with Lenders

Hospitality companies should open a dialogue with their lenders. If there is availability on lines of credit, discussions should include draw-downs to bolster liquidity. In addition, discussions may include forbearances, interest payment deferrals, amendments, extensions, restructurings, standstills, and borrowing availability increases or additional loans.

If the lender indicates willingness to support the continuation of the business in these uncertain times, the hospitality company needs to be transparent and candid, and provide information and analyses of the various possible scenarios to establish credibility with the lender.

The going concern value of a hospitality business usually exceeds liquidation value, especially under current circumstances. Hotels, timeshares, casinos, movie theaters, and restaurants are considered unique operating businesses within special purpose real estate. The operating business comprises the largest component of the asset’s value.

The growing levels of stress and distress may make lenders more receptive to alternative options to maintain going concern value until the businesses normalize. Lenders have incentive to work with hospitality companies to help preserve these businesses.

Update Cash Flow Forecasts

Forecasts need to reflect the current economic environment, projected out to account for reasonable upside, as well as downside, scenarios regarding the impact of the pandemic on operations—even including a potential second outbreak of COVID-19. These forecasts may be shared with lenders and other stakeholders, depending on circumstances.

Understandably, the current economic landscape may make forecasting difficult, as the severity and duration of disruption in the hospitality industry remains uncertain. Further, depending on the business and its location(s), normalization of business operations may take additional time. Accordingly, for many businesses in the hospitality industry, ramp-up may extend over a period of time, and they may face further disruption from changing consumer preferences or a second virus outbreak. Cash flow forecasts, however, must account for these uncertainties.

Hospitality companies should review their fixed and variable costs carefully and determine what costs are needed to run the business at current levels or at idle. Capital investment plans likely need to be revised and delayed. Companies need to assess their deferred expenses and make assumptions regarding the cost to ramp back up operations.

The 13-week cash flow model, which provides insight into sources, uses, and cash positions over the ensuing 90 days, can highlight some of the critical decisions needed. The 13-week cash flow model should be updated weekly and provide comparisons of actual against budgeted items, making available detailed information in advance of the typical monthly financial close process.

In going through this deep-dive process, hospitality companies may evaluate their core businesses, capital structure, supply chains, rent obligations, vendors, etc., and assess whether substantive changes are necessary or advisable.

Dialogue with Stakeholders

Companies should open communications with vendors, landlords, bondholders, equity holders, and other interested parties to assure them that they recognize the challenges presented by the coronavirus and have plans to address them.

In times of crises, communication with stakeholders remains vital. The stakeholders have their own concerns regarding the ultimate impact of coronavirus on their businesses and investments. Open discussions regarding the issues and challenges presented by this crisis establish goodwill and demonstrate a company’s intention to work with its stakeholders. These discussions do not need to express definitive solutions to the challenges, but are intended to reassure stakeholders that the company recognizes the scope and severity of the issues and is contemplating various responses, depending how facts and circumstances firm up.

Review Labor Issues

Labor constitutes a significant operating expense for most hospitality companies. Companies need to focus on whether to furlough or terminate employees, recognizing the costs and benefits of each option. By the time this article is published, many companies in the hospitality industry will likely have assessed these costs and benefits and made decisions; however, companies may need to reassess their decisions from time to time.

Meet Reporting Requirements

Companies in the hospitality industry that are publicly traded should review and make accurate required disclosures, in the event that business operations are impacted such that a reporting requirement is triggered under the Securities and Exchange Commission’s “‘34 Act.” All hospitality companies that are parties to credit agreements and other financing arrangements should review existing material adverse change (MAC) clauses and potential impacts on the borrower’s financial covenant compliance.

Investigate Government Assistance

Depending on their business, companies should keep apprised of the potential for government assistance. The CARES Act, signed into law on March 27, 2020, is a $2 trillion stimulus package intended to counter some of the economic devastation caused by the coronavirus. The law makes certain government loans available for the cost of rent and employees, which are forgiven when funds are expended on the required purpose. The timing and scope as to when and how much may ultimately be available remains unclear.

Specifically, the CARES Act:

  • Creates a $350 billion loan program to businesses that employ no more than 500 employees, allowing companies to borrow money to cover certain costs, such as payroll, healthcare benefits, rent, and utilities, among others.
     
  • Provides loan forgiveness programs through incentivizing business to retain and rehire employees.
     
  • Expands eligibility for Small Business Administration (SBA) loans, raising the maximum amount for these loans to 2.5 times the average monthly payroll costs, or up to $10 million, with interest rates not to exceed 4%, and waiving certain credit and personal guaranty requirements.
     
  • Adds relief for businesses in the accommodation and food services industries, certain franchise businesses, and small businesses that receive financing through the Small Business Investment Company Act.
     
  • Funds small-business education programs regarding COVID-19 and available federal resources.
     
  • Enables the U.S. Department of Commerce to give grants to minority business centers and chambers of commerce to educate, train, and provide access to federal resources.
     
  • Extends Emergency Economic Injury Disaster Loans (EIDL) eligibility to individuals operating sole proprietorships, independent contractors, etc., with no more than 500 employees.
     
  • Empowers the SBA to approve EIDLs solely on the basis of an applicant’s credit score or by use of alternative methods to gauge the applicant’s ability to repay.
    • Applicants may request an advance of up to $10,000 within three days after the administrator receives the application, which may be used for any allowable purposes under Section 7(b)(2) of the Small Business Act and is not subject to repayment, even if the loan request is ultimately denied.
       
  • Stipulates that, for loans under Section 7(a) of the Small Business Act, Title V of the Small Business Investment Act, and for loans made by an intermediary using Section 7(m) loans or grants, the administrator shall pay the principal, interest, and fees owed for loans in regular servicing status for any such loans, whether on deferment or not, that were made before the enactment of the act for the following six-month period, and for any such loans that were made between the date of enactment of the act and six months from such date.

  • Appropriates $17 billion to waive limits on the maximum loan maturities for loans given deferral.
     
  • Extends maturity during the year following enactment.
     
  • Stretches lender site visit requirement timelines as necessary due to COVID-19 to (i) 60 days of a non-default adverse event and (ii) 90 days of a default.
     
  • Provides tax relief to certain eligible employers
    • Eligible employers receive a credit against applicable employment taxes for each calendar quarter in an amount equal to 50% of the qualified wages with respect to each employee. The amount of qualified wages taken into account for each eligible employer, however, will not exceed $10,000 per calendar quarter and the credit will not exceed the applicable employment taxes owed for such calendar quarter.
    • Most employers may defer payment of Social Security tax.
       
  • Modifies net operating losses (NOL), providing a temporary repeal of taxable income limitation, including: (i) in the case of a taxable year beginning before January 1, 2021, the aggregate of the NOL carryovers to such year, plus the NOL carrybacks to such year, and (ii) in the case of a taxable year beginning after December 31, 2020, the sum of the aggregate amount of NOLs arising in taxable years beginning before January 1, 2018, and the lesser of the aggregate amount of net operating losses arising in taxable years beginning after December 31, 2017, or 80% of the excess of taxable income.1
     
  • Modifies limitation of losses for taxpayers other than corporations.
     
  • Modifies capital gains and losses, providing that deductions for losses from sales or exchanges of capital assets will not be taken into account and providing that the amount of gains from sales or exchanges of capital assets taken into account will not exceed the lesser of (1) the capital gain net income determined by taking into account only gains and losses attributable to a trade or business, or (2) the capital gain net income.
     
  • Accelerates the ability of companies to recover alternative minimum tax (AMT) credits that were repealed under the Tax Cuts and Jobs Act, permitting companies to claim a refund now and obtain additional cash flow during the COVID-19 emergency.
     
  • Increases the amount of interest expense businesses are allowed to deduct on their tax returns by increasing the 30% limitation to 50% of taxable income for 2019 and 2020.
     
  • Enables businesses, especially in the hospitality industry, to immediately write off costs associated with improving facilities instead of depreciating those improvements over the 39-year life of the building.
     
  • Provides a temporary exception from excise tax for businesses that distill spirits for use in hand sanitizer.

It is important for hospitality businesses to be aware of the resources available, including those in a second CARES Act, to help mitigate the effect of the coronavirus on their businesses.

Evaluate Insurance

Companies should review insurance policies to determine possible coverage and comply with all applicable notice requirements.

Although the most obvious source, most business interruption and extra expense insurance usually requires some sort of physical injury or damage to other business property as a trigger to coverage. Such coverage typically is designed to apply where a physical event (e.g., a building fire) shuts down operations for a period of time. It is unclear whether a claim premised on the physical illness of people necessary for business operations and government-ordered closures would be accepted. This issue should be examined on a policy by policy basis.

While somewhat uncommon, so-called “civil authority” coverage can be found in certain business insurance policies. These clauses were designed to insure against losses arising out of loss of income and extra expenses incurred in the event civil authorities prevent access to the business due to civil unrest or other emergencies. Coverage varies wildly depending on specific language used, but insured businesses should examine their coverage carefully to see if such protection is included.

While not as common as other insurance coverage, event cancellation insurance coverage in some form is often carried by businesses in the travel and entertainment industries, in particular. These policies are all written on nonstandardized, manuscript policy forms and should be carefully reviewed for potential losses associated with a canceled or postponed event. While many of the policies may contain some form of pandemic-related exclusions, depending on the exact facts and circumstances there may or may not be coverage for any particular losses.

In addition to seeking first-party coverage for business interruption and/or extra expenses, businesses may need to seek coverage from insurers for third-party claims for (i) negligence and injury related to the coronavirus or (ii) directors’ and officers’ liability for mismanagement of the business during the crisis.

Conclusion

In summary, the hospitality industry must take steps now to mitigate and address the impact of the coronavirus on businesses in the sector. These steps include a number of tools and analyses commonly employed by restructuring professionals, which can and should be used by companies in the hospitality industry to survive the current crisis.

Originally published in Journal of Corporate Renewal in June 2020.

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Speak with your tax professional regarding the specifics on any potential tax issues facing your business.

 

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