Industry Update
Opinion Article24 November 2020

Never buy a hotel without a good representations and warranties agreement

By Christopher Boinet, Lawyer at the Paris Bar and Partner at In Extenso Avocats and Anne Epinat, Partner In Extenso Avocats and François Gérard Mondi , President at In Extenso IDF

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Christopher  BoinetChristopher Boinet
Anne  EpinatAnne Epinat
François  Gérard Mondi François Gérard Mondi

With an asset and liability guarantee agreement (Garantie d'actif et de passif, or GAP, under French law), the buyer obtains a contractual warranty for ensuring that the price it is paying matches the value of the company being sold. A post-sale tax adjustment or industrial tribunal proceedings in favour of an employee? A GAP agreement covers disputes prior to the sale, if these disputes were undeclared or if insufficient provisions were made for them.

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The crisis that the hospitality sector is currently navigating is leading hotel investors to adopt a cautious approach, and to step up negotiations. Investors may, for example, demand:

  • Buy-side due diligence to identify risk factors;
  • An asset and liability guarantee agreement (GAP).

If the parties elect not to include a GAP agreement in a hotel sales agreement, the purchase price is reduced accordingly.

With a GAP agreement, the buyer gains a contractual warranty for ensuring that the price it is paying matches the value of the company being sold.

The buyer negotiates with the seller to obtain its promise that the value and reality of the assets and liabilities comply with its representations - or statements - regarding the company, the operating property, industry standards and the accounts communicated.

If it transpires after the sale that the seller's representations or warranties are inaccurate, or if an incident occurs whose cause can be traced back to an event that took place prior to the sale, the buyer may bring an action for damages, claiming a reduction in the price of the asset or compensation.

A post-sale tax adjustment or industrial tribunal proceedings in favour of an employee? A GAP agreement covers disputes prior to the sale, if these disputes were undeclared or insufficient provisions were made for them, regardless of whether the risk was known to the buyer before the sale took place (see: Cass.com.3-5-2018 n° 16-23.817 F-D, G.C/Sté Mulberry).

What happens if there is no GAP agreement, or if limits are imposed?

In major investment fund sales transactions, it is common for no GAP agreement to be signed, since the fund that is selling does not wish to commit to something that may harm its future performance.

The parties are also free to impose limits in GAP agreements by excluding liabilities that are not recorded in the balance sheet or for which insufficient provisions were made. However, the buyer is nevertheless aware of these liabilities.

For example, in a case involving the sale of a small Parisian hotel in the 8th arrondissement, the deed of sale excluded any GAP agreement benefits if a tax audit were to be conducted after the sale, and if it were to be discovered at the time of the audit that the new representative of the company, or its employees, agents or representatives, had directly or indirectly engaged in "pimping" or other prohibited dealings.

When a GAP agreement is envisaged, its clauses must be meticulously examined and painstakingly negotiated.

A GAP agreement generally comprises two key components: the representations - or statements - component, and the warranties component. Both must be studied carefully, as the stakes are so high in hotel transactions.

- Statements relating to the hotel operation. The GAP agreement will specify whether the hotel has all the required authorisations to operate (occupation of the public domain - such as a terrace or beach - licence to sell alcohol, etc.), in compliance with the applicable regulations on health and safety, public access, disabled access, hygiene, hotel classification, etc.

The seller will state that the hotel is not in danger of being ordered to close and that it has not been subject to any downgrading, nor is it the subject of any investigation that could lead to it being downgraded.

The buyer will ensure that all of the works required or recommended by the safety commission have been carried out or are in progress and, in any event, that these works have been paid for, or sufficient funds allocated in the reference accounts referred to in the GAP agreement.

- Specific statements on intellectual property and the GDPR. The guarantor must declare that the operating company is the full and valid owner of intellectual property rights, trademarks, domain names and all other rights that may benefit from legal protection by the company. Finally, the guarantor will make all the necessary commitments related to compliance with the GDPR standards in force - these are imperative in hotel matters, and may prove to be very costly. They can be the subject of a specific guarantee.

Buyer negotiations

The duration of a representations and warranties agreement is most often negotiated on the basis of labour law, tax and customs regulations or social security disputes. Attention should be paid in the event of a deficit, especially if the future tax savings have been valued. The guarantor should always make sure to cap the amount that should be paid in the event of a breach of its representations and warranties – either a quantified amount or a percentage of the sales price. The guarantor will often resolutely negotiate a gradual reduction in this guarantee amount over time.

Lastly, parties generally provide for a grace period before the guarantee is triggered.

When the owner company of the hotel business is held by members of the same family, or if several sellers are involved, the question arises as to who provides the GAP agreement and whether or not the sellers should act jointly and severally on this point.

The final step in the negotiation process: guaranteeing the warranty

To ensure the payment of the sums due in the event that the warranty is called upon, the beneficiary of a GAP agreement will generally require additional commitments from the seller. These can include:

  • A demand guarantee to avoid the risk of discussion, a bank guarantee, a guarantee granted by the seller's parent company, or - the most frequent, in practice - the holding in escrow of a proportion of the sales price on the lawyer's CARPA [1] account.
  • A tangible warranty from the guarantor: the guarantor can assign, as security, a proportion of the sales price to the buyer, or offer a hypothec or collateral (less frequent, in practice).
  • A deferral of the payment of part of the sales price, or the retention of sums left in a partner's current account (sellers are wary of such practices, and these remain rare).

This bitter negotiation is one of the most strained moments in the discussions, as it is up to the prospective buyer to prove the risk they incur and the extent of the warranty they are seeking from the seller.

To sum up

In principle, the guarantee amount must be negotiated and set as objectively as possible. To this end, it is necessary to take into account the risk incurred by the buyer, who is seeking security, and the seller’s desire to receive the full sales price and to no longer have to worry about the asset being sold. Based on the many hotel sales that we have handled, the average guarantee cap, in our experience, is around 10% of the sales price.

The buyer also often requires that payment of the guarantee amount be guaranteed by the seller. This amount can be negotiated at around 5 to 10% of the sales price.

Exceptions are, however, very common and depend on the circumstances of the sale in question, the temperament and personality of the parties involved, and the experience of those advising them.

[1] CARPA: Caisses des Règlements Pécuniaires des Avocats - Fund for Lawyers' Pecuniary Settlements.

Christopher Boinet

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Anne Epinat

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François Gérard Mondi

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