Hotels had braced for a temporary disruption to their businesses during the pandemic, but that disruption has extended, and now the industry is getting a wake-up call. With a still-staggering market and shrinking federal support, some of the hospitality industry’s most vulnerable are grappling with bankruptcy.

From the pandemic’s outset in March 2020, hotels experienced a drastic plunge in their occupancy rates and a dramatic drop in their bottom line. But an immediate wave of bankruptcies didn’t follow despite some industry experts anticipating it, largely thanks to government support and emergency infusions of cash. More than a year and a half later, that funding has waned, and occupancy rates haven’t rebounded to normal levels.

According to bankruptcy attorney Robert Marticello, hotels that had prepared for Covid-19 to be a sprint are now grappling with the realities of a marathon.

“Initially, a lot of people thought this would be a three-month issue,” said Marticello, a founding partner at downtown law firm Smiley Wang-Ekvall, which specializes in insolvency, real estate and business litigation. “As the pandemic progressed, we quickly realized we were in for a longer haul than we originally believed and needed to adapt.”

If hotels in general are feeling the economic wrath of the pandemic, hotels in areas that rely on recreation and travel are experiencing it twofold. This month, Marticello closed the sale on a flagged 200-room, full-service hotel in Orange County for $21.5 million as part of a Chapter 11 bankruptcy case. The hotel relied on its proximity to Disneyland and other local theme parks for the bulk of its business, Marticello said.

“Occupancies and operations improved as the local and U.S. economies seemed to recover and when the theme parks reopened, in particular,” Marticello said. “But then hotels struggled to hire back employees …. The theme parks have reopened, but hotels are not back to the pre-pandemic normal due to repeated resurgence of Covid-19 and issues with travel limiting out-of-town guests and business travelers.”

Lenders checking out

Marticello said lenders in the early months of the pandemic were almost universally willing to forebear and defer, with some stipulations, in order to allow the borrower time to recover.

“But you did have exceptions to that, often in cases where the lender believed there were other problems beyond the effects of Covid-19,” Marticello said. “This goes beyond hospitality — you’ve seen it with retail, with restaurants and real estate.”
Now the patience of many lenders appears to be growing thin, according to Brian Davidoff, chair of the bankruptcy, reorganization and capital recovery practice at Century City-based Greenberg Glusker Fields Claman & Machtinger.

Davidoff said the hospitality industry has remained relatively healthy thanks to Covid-related government funding and regulations that suspended certain reporting obligations.

“Currently, banks and lenders don’t need to do what’s called a TDR, a troubled debt restructuring, for a Covid impairment,” Davidoff said. “(Typically) the lender would be obligated to write down the asset to the extent of the impairment on their books,” said Davidoff. “So there hasn’t been financial pressure on the lenders to deal with assets as they otherwise would have.”

But those regulations expire Dec. 31 and are unlikely to be extended again, Davidoff said. This will likely encourage lenders to get more aggressive, particularly with assets underperforming the market. Davidoff suspects this could trigger an increase in bankruptcies as fed-up lenders look to settle losses.

Waiting for stabilization

Still, Davidoff suspects the road to recovery will be long, and in many cases, extremely challenging. Even some of his most stable clients are dealing with significant deficits with lenders created over the course of the Covid-19 pandemic.
“It’s not even getting back up to full occupancy that would make this up,” Davidoff said. “You can’t make that up after a year of nonpayment.”

David Kupetz, a partner at downtown-based financial restructuring and litigation firm SulmeyerKupetz, said much of the firm’s bankruptcy work on behalf of hotel clients has been dedicated to helping clients defer the need for restructuring. Kupetz said his firm’s hospitality clients are typically mid-sized, including a large restaurant group with locations throughout California and a hotel with approximately 180 high-end accommodations and a special event venue.

The hotels the firm has worked with have stayed solvent, largely thanks to government funding, but Kupetz said more clients are at least considering the possibility.

In one instance, Kupetz said, the firm represented a client in negotiating an extended interest-only payment period from their secured lenders. In another case, the firm assisted a client in negotiations with a number of landlords who agreed to rent concessions, such as rent forgiveness for a number of months and then a reduction below the contract rate for a significant period of time, with rent escalating over time back to the contract rate.
 
“These consensual arrangements allowed the client to address liquidity issues (and) constraints without having to resort to Chapter 11,” Kupetz explained.
 
Even with an optimistic timetable for recovery for some clients, Kupetz said, there’s an expectation that bankruptcy filings will increase once the market stabilizes as a way to fix problems created by Covid and “reset the balance sheet.”

While the market as a whole seems on the mend, Marticello has good reason to brace for more unexpected turmoil. He pointed to the most recent summer as evidence: While many industry experts had anticipated that an upswell in pent-up travel demand would provide hotels some relief, those hopes were dashed relatively quickly by the delta variant surge.

And maybe a bit of luck. While a hotel next to theme parks might feel the full brunt of the pandemic, his clients with hotels near beaches or out closer to natural, scenic attractions like state parks and hiking areas are faring much better.

“It’s not affecting all hotels equally,” Marticello said. “It’s very dependent on niche.”