Hospitality Lawg - Commentary on hospitality law, news and developments

The ARDA International Foundation has recently released an interesting study focused exclusively on resorts controlled by home owner associations.  The three academics behind this first-of-its-kind report were looking to "identify those factors that effectively contribute to success or failure in HOA controlled resorts."   

The survey focused on the following broad topics for this important timeshare subgroup:

• Identification of basic resort characteristics
• Governing Board structures and characteristics
• Financial metrics (including reserve funds)
• Rental, resale and exchange

A couple of the more interesting findings:

1. Financial metrics suggest that, on the whole, resort operations are in fairly good shape. Notably, recent maintenance fee increases were not reported as "significant," a position which seems to be supported on a historical basis.  However, readers of this section of the report should probably also check out this article in the January edition of Developments:  Benchmarking Study Shows Tough Times Ahead for HOAs.   
2. Confirming something we touched on previously, owners are generally not getting much assistance with rentals or resales.  Only 54% of participating resorts had a rental program for owners, and the average nightly rate was $90, or less than 60% of the rate reported for the timeshare industry as a whole.  Worse, only 28% had a resale program to help owners sell their timeshares.    

Time to revise your form investment documents - as of February 27, 2012, the Securities and Exchange Commission's new accredited investor rule will take effect.  Affirming accredited investor status is crucial in determining whether an investment falls under the Regulation D safe harbors and qualifies for exemption from some of the more onerous and expensive disclosure obligations otherwise required by the Securities Act. 

Overview of the Changes

The change is substantially consistent with the proposed rules Jason Brady discussed in his blog from February 2011.   As dictated by Dodd-Frank, the calculation as to whether of person's net worth (or joint net worth with spouse) exceeds $1M must exclude the value of that person's primary residence, but indebtedness secured by that residence will not count as a liability (to the extent the debt does not exceed the fair market value of the residence).  In other words, positive equity will not count, but negative equity will. 

The SEC did address two new issues in the final rule as a result of comments received on the proposed rule:

• Indebtedness secured by a primary residence in the 60 days preceding the purchase of securities will reduce net worth, irrespective of the residence's fair market value, unless such debt was incurred in connection with the acquisition of the residence.  This provision was added to reduce any temptations on the part of investors or salespersons to "game" the calculation rules by artificially inflating net worth.
• Cognizant that some current investors would no longer qualify as accredited under the new rule, the SEC also added "grandfathering" provisions.  First, binding investment obligations made prior to Dodd-Frank will be judged using the old rules.  In addition, the old rules will apply to follow-on investments (i.e., exercise of pre-emptive rights) if the investor: (a) acquired a right to purchase prior to July 20, 2010; (b) qualified as an accredited investor at the time the right was acquired; and (c) held securities of the issuer (other than the right in (a)) at that same time. 

With respect to the above, note that the SEC declined to engage in the complexity of defining "primary residence" as that term has "a commonly understood meaning as the home where a person lives most of the time."          

Looking Forward

Dodd-Frank also required the SEC to undertake a review of the definition of "accredited investor" every 4 years from the enactment of Dodd-Frank.  However, the SEC has chosen to delay any action on this obligation until after the Comptroller General completes its related Dodd-Frank obligation - a report on "the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds."  According to the SEC, this study, due before the end of 2013, "will be taken into account in any rulemaking that takes place in this area."    

Back in March, the Hospitality Lawg took its first look at the securities litigation surrounding the Trump SoHo, a New York condominium hotel.  The plaintiffs' primary beef was that they had bought under the impression that 60% of the units were sold, when at the time the developers had closed on just 16% of the units.

You may have noticed that it was our only post on this litigation - there hadn't been a single new filing in the court's record since the plaintiffs and defendants had traded memorandums of law on the defendant's motion to dimiss back in March.

That is, until November 8, when the parties' stipulation of dismissal was filed.  As reported by Steve Cuozzo of the New York Post:

They cried 'fraud' - an now, a bunch of well-heeled apartment hunters will get a staggering 90% of their deposits back on posh pads they intended to buy at the troubled Trump SoHo condo-hotel because they relied on the developers 'deceptive' sales figures.

While the result is presumably good news for the parties involved, we were hoping to see the judge analyze the plaintiffs' contention that the developers structured the rental program to “virtually ensure that all unit owners will use Trump Hotels to rent and manage their units,” thereby coverting the unit purchase agreements into investment contracts (a/k/a securities) required to be registered with the SEC and the New York securities commission.  

For those fans of condotel securities litigation, Tarsadia is still working its way through the appeals process.  

Marriott International, Inc. (NYSE:MAR) announced the approval of the spin-off of Marriott Vacations Worldwide Corporation through the distribution of shares to holders of Marriott International common stock.  As discussed in our prior posts, Marriott Vacations Worldwide will become the market’s largest pure-play timeshare company.  Details from the press release include the following: 

• Marriott Vacations Worldwide will be the exclusive developer and manager of vacation ownership and related products under the Marriott brand and the exclusive developer of vacation ownership and related products under the Ritz-Carlton brand. 
• The spin-off will be completed through a pro rata dividend of Marriott Vacations Worldwide common stock on Monday, November 21, 2011 to Marriott International shareholders of record as of the close of business of the New York Stock Exchange on Thursday, November 10, 2011.
• Each Marriott International shareholder will receive one share of Marriott Vacations Worldwide common stock for every ten shares of Marriott International Class A common stock held.
• Following the spin-off, Marriott Vacations Worldwide intends to have its common stock listed on the NYSE under the symbol “VAC.” 

If there was such a contest, the 232-unit Spa at Sunset Isles would be in the running for "worst case scenario" condo-conversion.  Here is a summary of the development's situation as it existed in late 2010:  

• Although initially priced at $250,000, the average unit price had sunk to $48K, a drop of over 80%
• The average first mortgage debt was approximately $218,000
• More than 180 mortgage foreclosure proceedings had been commenced
• The foreclosures had been pending for an average of 736 days, with the oldest one-third pending for more than 1011 days on average
• No assessments were being paid with resopect to almost 70% of the units

Obviously, the first step in fixing the problem would be to start collecting asessments again.  However, as pointed out by Sun-Sentinel reporter Daniel Vasquez, banks had no incentive to foreclose on the underwater properties and assume the assessment obligation.  And Florida courts had clearly rejected the argument that "equity and fairness" could support a court order requiring mortgagees to pay assessments while foreclosure proceeding are pending.

But if necessity is the mother of invention, bankruptcy is invention's power tool.  Ignoring the Tadmore precedent in Florida, the Sunset Isles HOA filed bankruptcy and asserted in its Plan of Reorganization that it had the right to surcharge the mortgagees under 11 USC 506(c).  That bankruptcy code section states:

The trustee may recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim. 

Of the over 250 mortgagees, only OneWest Bank filed a response in opposition.  The Court agreed with OneWest that the Florida condominium law shields the holder of a first mortgage from paying assessments until the mortgagee takes title.  But the Court ultimately rejected OneWest's argument, holding that:

When the Bankruptcy Code and state law conflict, the Code takes precedence over state laws under the Supremacy Clause.

The Vasquez article above posits that this decision breaks new legal ground.  Skeptical, we did our own WestLaw search.  And it looks like Vasquez was right - we did not find any prior cases involving an owners' association making use of 11 USC 506(c) in this way.    

The September issue of Developments Magazine features an article titled Rx For Your Fiscal Health - Annual Checkup on Your Resorts and HOAs.  In putting the story together, Geri Bain interviewed Kurt Gruber, Baker Hostetler partner and Hospitality Lawg Editor.  Although the article provides insights from a host of industry professionals, we are republishing here Kurt's comments in full. 

Question #1:  With the recent economic challenges, what has changed in regard to maintenance fee collections?  When did you start seeing the change?  What does this “new world” look like?  Have you seen any problems with real property tax collections (if they are billed separately)?

As one might expect, the downturn in the economy and the resulting financial challenges faced by people at all income levels are having a significant impact on maintenance fee collections.  Timeshare managing entities continue to experience this negative impact across the full range of product types and prices, from traditional, basic timeshare projects to high-end, full service fractional resorts.

The increase in collection challenges is not just a result of the economic hardship faced by individual shared ownership owners, but a combination of a number of circumstances that have created a “perfect storm” for managing entities.  One of the exacerbating factors is the fallout from those timeshare development companies who now carry a larger maintenance fee and tax obligation as a result of an overabundance of unsold inventory that was constructed to support a sales and marketing effort that is no longer sustainable.  Another element is the aging of industry product, with many projects now in their second and third decades and with a growing number of owners who love the product and who previously paid their maintenance fees on time, but who are now looking for an exit strategy and a way to reduce expenses as their lifestyles change.  A third consideration is the large number of timeshare interests that are stuck in limbo because the timeshare owner is in default of both the obligation to pay maintenance fees and taxes and the obligation to pay a mortgage payment.  Lenders who have no outlet to resell interests taken back in foreclosure are slow to recover inventory for which they will then be liable to pay maintenance fees and taxes going forward until they can arrange a transfer to another party.

This change in maintenance fee collections began in late 2007, picked up steam in mid-2008 as a result of the sharp increases in gas prices, and dramatically accelerated at the end of 2008 when the entire economy began to falter.  Since then there has been some improvement, especially as less stable owners have defaulted and moved out of the system; however, this improvement has not occurred at the pace that managing entities want to experience.  The “new world” will continue to include steady improvement in collections, and I do not see another dramatic spike in defaults on the horizon so long as the recovery progresses; however, management will continue to need to diligently and aggressively address collection issues.

In my experience, there is not a significant distinction between the payment and collection of maintenance fees and the payment and collection of real property taxes.  If the consumer is willing and able to pay the one, then he or she will generally pay the other.  This is true in part because owners often do not focus on these fees and taxes individually, and in part because there is not any real benefit to paying one but not the other – that is, the timing, process and result of a foreclosure action is generally the same for both.  The same is not true with respect to the payment of maintenance fees and taxes and the payment of mortgage obligations.  Since the obligations are owed to different entities and the remedies for failure to pay may be different, some consumers will pay one but defer the payment of the other.

Question #2:   How have managing entities responded and how have you helped resorts and owners respond to these challenges?  

The responses to the collection challenges faced by associations and management companies vary depending on such circumstances as the differences in options and remedies available in different jurisdictions, structures and governing documents.  Some common approaches do exist.  The first goal in most situations is to attempt to keep the consumer in ownership.  This will save a significant amount of money by avoiding the costs of foreclosure and reselling as well as limiting the problem of the association owning the inventory instead of a paying owner.  To that end, the managing entity needs to actively engage the delinquent owner, including re-connecting the owner with the use of the product or providing flexibility in payment options (such as creating a payment plan or waiving late fees and interest).  If no arrangement can be made with the owner, the managing entity must take increasingly aggressive steps to encourage payment.  These steps start with lock-out of use and exchange, where permitted, and end with the imposition of a lien and ultimately, foreclosure.  In some situations, it will make sense to retain a third party collection company that has more experience in debt collection.

On the creative side, I have worked with associations and companies to develop strategies that allow for amnesty from some of past due fees and taxes in return for a partial payment (where permitted under applicable law) and facilitating and encouraging the transfer of the timeshare interest to a person capable of making the payment, like a relative or another owner at the resort looking to pick up an additional timeshare interest.

Question #3:   Are you seeing an increase of individual owners using relief or transfer companies for their timeshare interests?  What long-term impact can this have on a resort?  Have you found ways to circumvent or solve this problem?  Is this having an impact right now?

It is definitely having an impact.  I have also seen an increase in owners hiring companies to dispute their original purchase and try to force the developer to rescind the sale, even if the transaction occurred years ago.

If all timeshare relief or transfer companies were well-capitalized, ethical, fulfilled their obligations and made good on their promises, the services they provide would be a boon to a struggling association or resort by facilitating the transfer of ownership from a defaulting or defaulted owner to a paying owner.  Unfortunately, there currently are many more bad players than good operating in this space.

All the bad activity in this area creates its own significant problems.  In particular, many of these companies take the owner’s money and provide no real service in return, simply “listing” the timeshare interests for resale on an inactive internet site.  The owners are still dissatisfied and have even less money to pay the resorts.  Some companies take an owner’s money in return for a promise to transfer the property to a third party but never complete the transfer.  In these situations, the past due maintenance fees and taxes may not get paid; the original owner stops paying maintenance fees and taxes and is no longer active with the resort; the transfer company does not have title and therefore has no obligation to pay; and no new owner exists to make the maintenance fee and tax payment.  Under other scenarios, the transfer company will take title to the timeshare interest but may not pay past due maintenance fees and taxes, does not pay new maintenance fees and taxes and either lets the timeshare interests sit in a default status (thereby forcing the association to incur foreclosure costs) or bankrupts the transfer company and sets up a new one.  In each of these instances, the association accumulates an ever growing bad debt and often is unaware that a transfer has occurred and no longer has a clear understanding of its owner base.  This is a current and growing problem.

Short of supporting owners who pursue a complaint with the appropriate regulatory agency or a claim for fraud or violation of an applicable consumer protection law, the managing entity will have limited options to circumvent problems created by unscrupulous timeshare relief or transfer companies.  It is imperative for the managing entity to develop an owner education program using newsletters, alerts and association meetings to educate owners of the potential shortcomings of these companies.  Developing a strong resale program through cooperation with the existing developer or a viable, ethical resale provider is potentially the best solution because it provides a meaningful and safe method for owners to transfer their timeshare interests to a new paying owner. 

Question #4:   How do you handle the defaulted weeks?  Do you foreclose?  What are the advantages/disadvantages in this?

As previously noted, the best solution for dealing with defaulted timeshare interests is to attempt to engage with the defaulting owner to develop a solution, get them using the product again and hopefully get some payment in the door.  If all else fails, foreclosure is the only alternative.  The major disadvantages of a foreclosure action are the cost and time that it takes to complete the recovery of the inventory.  In some jurisdictions, attorney’s fees and court costs can exceed $1,200 per timeshare interest.  Court systems already bogged down with an ever-increasing number of home foreclosures struggle to process thousands of timeshare foreclosures, resulting in a judicial foreclosure period that can last as long as eighteen months.

Non-judicial foreclosures (in jurisdictions that recognize such) occur outside of the courts and can greatly reduce the time and expense of the foreclosure process.  In this regard, I played a significant role in ARDA-Florida’s recent successful effort to obtain the passage of a non-judicial foreclosure process for timeshares in Florida, which was a first of its kind law that we are hopeful will make a big difference in the expense and time delay currently experienced by associations in Florida.

One advantage of the foreclosure process is that it does motivate some defaulting owners to pay past due maintenance fees and taxes.  Many owners will not take any action until the receive the formal court papers, but then will bring their account current rather than risk the loss of their timeshare interest or a potential negative credit report.

Question #5:   Do you have any advice and/or cautions for resorts facing large numbers of defaults and/or delinquencies?

The best advice I have is to develop a multi-level strategy that is consistently and aggressively implemented.  As is usually the case, complex problems require complex solutions.  The managing entity that can marshal and coordinate many different resources has the best chance of at least holding its own until the economy improves or better paying owners replace delinquent ones.  Associations and management companies should not be slow to act, since carrying a large amount of defaulted inventory can lead to a death spiral where paying owners who are increasingly shouldering an expanding bad debt expense or see the quality of the resort significantly deteriorate cease to make payments and the resort eventually goes bankrupt.  Instead, best practices should include assembling a team comprising properly trained, internal staff focused on re-engaging the owner and outside legal, accounting, title and collection experts who can tackle the problem on many fronts.

Question #6:   Is there anything else you’d like to add?

First, associations and management companies must know the documents that govern their resort and the assessment and collection process.  Simply relying on practices developed at other projects or as set forth in applicable laws may result in the violation of provisions of the timeshare documents and invalidate the activity or expose the managing entity to liability.  It is worth hiring an attorney to review the documents and provide advice on the interplay of the documents and applicable law.

Second, managing entities handling collections need to be aware of the accounting and legal limitations and restrictions involved in the process.  For example, the managing entity is well advised to seek out expert accounting advice to properly account for bad debt and efforts to write-off bad debt.  In addition, there are many laws that apply to the managing entity’s collection activities such as the federal Fair Debt Collection Practices Act; state timeshare or condominium laws restricting waiver of past due maintenance fees or the improper use of reserve funds to pay for operating expenses; or engaging in collection efforts by non-attorneys in violation of statutes governing the unlawful practice of law.  While it may be tempting to avoid spending the money by going it alone, the potentially severe consequences of evading applicable accounting rules or laws may outweigh the few dollars that are saved.

A lot has happened since we last reported on the Consumer Financial Protection Bureau.  Frankly, too much to summarize coherently at the hour this post is being written.

But we do feel obliged to report on the status of the Interstate Land Sales Full Disclosure Act.  As we reported on July 21, there were some questions about the transfer from HUD to the CFPB of ILSFDA enforcement authority.  To us, the most significant was whether hospitality developers could continue to rely upon the Guidelines for Exemptions Available Under the Interstate Land Sales Full Disclosure Act. 

Based on the discussion during a July 14 CFPB teleconference, the answer seemed to be a clear “no.”  This was problematic as the Guidelines (in their various iterations) have played a substantial role in the administration of ILSFDA over the past 25 years.  

However, the CFPB has since issued guidance stating in part that:

Later this year, the CFPB intends to publish . . . the rules, including HUD’s ILS rules, for which rulemaking authority transfers to the CFPB. . . . In the interim, the existing rules will continue in effect and the changes made by [Dodd-Frank] to transfer authority to the CFPB will be effective as of the designated transfer date by operation of law.

So are the Guidelines “rules” for purposes of this guidance? 

Possibly, but you’ve got to follow along:

• As we previously reported, the CFPB was obligated to publish a notice in the Federal Register stating the “rules and orders” it would enforce.
• The CFPB included among those rules “24 CFR Part 1710—Land Registration”
• In footnote 8 of that notice, the CFPB stated: “Unless otherwise noted, all references to a Part include accompanying appendices and supplements.”
• The official title to the Guidelines begins “Supplemental Information to Part 1710.”

Feel confident?  

Back in June, we reported that the SEC was showing some interest in the dismissal in Salameh v. Tarsa­dia Ho­tels. Nonetheless, we were surprised when we reviewed “What’s New at the SEC” and saw that the SEC had filed a friend of the court brief in favor of the plaintiff purchasers.  In stating its interest in the case, the SEC reported that it was concerned that:

The district court’s holding on the investment contract issue, unless reversed . . . would impermissibly allow a promoter to avoid the coverage of [the securities laws] by (1) artificially dividing a single investment transaction into ostensibly separate parts, and (2) including written disclaimers that falsely state that there is no investment expectation.   

A Single Transaction? 

In granting its dismissal in Tarsadia, the U.S. District Court for the Southern District of California determined that plaintiffs could not credibly allege the existence of a single “investment contract” given the 8 to 10 month gap between the plaintiffs’ execution of the purchase agreements and the rental management agreements. 

The SEC argues in its brief that, in reaching this conclusion, the court “failed to appreciate the broader realities underlying the arrangements between the parties.”  Specifically, the SEC argues that the hotel regime documents effectively denied the plaintiff purchasers any meaningful use or control of their hotel rooms, instead reserving that control to the hotel operator at inception.  The SEC also points out that this allocation of control was consistent with the developer’s plan to operate “a functioning, economically viable hotel.”  The SEC concludes as follows:   

The fact that Tarsadia did not make the Rental Management Agreement available until a year after the room sales is of little or no consequence. This is particularly so given that the Hotel was still under construction throughout the entire period in question, and did not finally open until several months after Tarsadia formally offered the rental management program. Tarsadia’s ability to delay having the plaintiffs actually execute the Rental Management Agreement should not disguise the economic and practical reality here: Tarsadia’s operation of a rental management program was at all times here a necessary and essential component of the room sales, making the two a single transaction or package.

Expectation of Profit?

The dismissal in Tarsadia was also based upon the court’s conclusion that the plaintiff purchasers could not demonstrate any reasonable expectation of profit because the purchase agreements contained express representations that there was no investment intent.

In disputing this conclusion, the SEC again argued that the court was missing the forest for the trees.  Contractual language notwithstanding, the court should have recognized that the purchasers were “led to expect profits from the defendants’ efforts.”

The danger with the district court’s approach lies in the fact that, were it allowed to stand, it could provide an easy mechanism for those seeking to avoid the protections that the securities laws afford investors.  It is essential, therefore, that written representations or warranties not trump the economic and practical realities of a transaction that otherwise qualifies as an investment contract.

We would like to thank our friends and clients who responded to the most recent Chambers survey.  For those not familiar with Chambers, its intensive and unbiased survey methods make it the most respected legal directory available.   

Based on the strength of comments Chambers received, Baker Hostetler was, for the 4th year in a row, recognized as having one of the country’s strongest hospitality law practices.  Most impressively, we were one of only three firms recognized for excellent client service and keen commercial awareness.  As stated by some survey respondents:       

They have our interests at heart

Their focus is bringing all the parts together

We would also like to congratulate Rob Webb and John Melicharek as Chambers made special note of their exceptional skills.  Rob was highly recommended by peers as an acknowledged expert in timeshare-related matters.  As for John, Chambers quoted one survey respondent as follows:

He understands that it's not just about the fundamentals, there's business implications as well. He finds ways to get a deal done, and he also has a very good sense as to which issues are important and which aren't, and that saves us time.

Overall, Chambers recognized Baker Hostetler in 14 different practice areas:

• Bankruptcy/Restructuring
• Construction
• Corporate/M&A
• Corporate/M&A & Private Equity
• Employee Benefits & Executive Compensation
• Healthcare
• Intellectual Property
• Labor & Employment
• Leisure & Hospitality
• Litigation: General Commercial
• Natural Resources & Environment
• Real Estate
• Tax
• Zoning & Land Use

We reported on developments with the Consumer Financial Protection Bureau (CFPB) back in January and March.  The hospitality industry has an interest in the development of the CFPB because the agency has broad authority to prevent acts or practices which are "unfair," "abusive" or "deceptive."  In connection with that mission, the CFPB may revisit or invent definitions for "deceptive," "unreasonable advantage of consumers' . . . reasonable reliance" and "covered persons."    

Staking Out Its Turf . . . 

While the rumored recess appointment of the CFPB director did not come to pass, the Federal Register did publish on May 31 a list of rules and orders that the CFPB would have authority to enforce.  While that list isn't final, it does provide some insight as to the scope of the CFPB's broad regulatory power.  Here are some the listed rules and orders that may be of particular interest to the hospitality industry:   

• The Federal Trade Commission’s Telemarketing Sales Rule (16 CFR Part 310) and Rule Concerning Cooling-Off Period for Sales Made at Homes or at Certain Other Locations (16 CFR Part 429), as well as rules pertaining to the Preservation of Consumers’ Claims and Defenses (16 CFR Part 433), Mail or Telephone Order Merchandise (16 CFR 435), and Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunities (16 CFR Parts 436 and 437).
• The Department of Housing and Urban Development rules regarding Land Registration (24 CFR Part 1710) and Purchasers’ Revocation Rights, Sales Practices, and Standards (24 CFR Part 1715).
• Real Estate Settlement Procedures Act (RESPA), 24 CFR Part 3500. 
• The rules regarding the privacy of consumer financial information currently enforced by the Fed, the FDIC, the OCC and the OTS.

. . . With Some Caveats

Not surprisingly, we found some interesting nuggets when reviewing the release: 

• This list was published by the Secretary of the Treasury, which has interim authority to perform certain CFPB functions (see footnote 6 in the notice).  Even so, as of June 12, the CFPB’s website had no mention of either the May 31 notice or the list of rules proposed to be enforced by the CFPB.
• As to the FTC’s Telemarketing Sales Rule, the CFPB will only “have authority to enforce in some circumstances” that rule.  While specific exceptions to CFPB enforcement authority were spelled out elsewhere (i.e., Fair Credit Reporting), the notice does not detail what was meant by “in some circumstances” with respect to the Telemarketing Sales Rule.
• The notice states very clearly that it does not in any way limit the CFPB’s enforcement authority as defined by Dodd-Frank:

[T]he inclusion or exclusion of any rule or order would not alter the CFPB’s authority.  In addition, section 1063(i) does not require the CFPB to update, correct, or otherwise maintain the final list.  Because the list under section 1063(i) reflects the CFPB’s interpretation of its authority under [Dodd-Frank] and relates to agency organization, procedure and practice, the list is not subject to the notice-and-comment requirements of the Administrative Procedure Act.  Nevertheless, the Bureau invites public comment during a thirty-day period.

Why does the Consumer Financial Protection Bureau Matter?

The Dodd-Frank Wall Street Reform and Consumer Protection Act created the Consumer Financial Protection Bureau, a new and powerful federal bureaucracy with a mandate to enhance consumer financial protection under a host of new and existing consumer protection laws.  According to the current schedule, the CFPB will absorb a significant portion the consumer protection functions (research, rulemaking, guidance, supervision, examination and enforcement) of the Federal Reserve, the FDIC, the FTC, the NCUA, the OCC, the OTS and HUD as of July 21, 2011.   

Depending on how the mandate is implemented, it could result in a shift from a disclosure regime towards a rules-based regime - a change that would invite both federal and state regulators to take a fresh look at some long-standing interpretations of separate but related consumer protection laws.  As such, the methods by which fractionals, timeshares and travel club memberships are sold and financed are potentially subject to some significant changes.   

Hospitality Lawg Updates

Given this potential, the Hospitality Lawg will be tracking CFPB developments and report on them as appropriate.  In early January, we reported on some initial organization and staffing developments at the CFPB.  This post focuses on developments from February.

• Big Bureau, But Leader Still Undetermined

President Obama's budget contemplates over 1200 hires at the CFPB.  But with only a little more than 5 months before the July 21 launch date, President Obama has not nominated a director for the CFPB.  Without a director, Sheryl Harris at the Plain Dealer reports that the authority of the CFPB may be significantly limited.  And Brady Denis at the Washington Post reports that the US Chamber of Commerce is taking steps to confirm that limit on the CFPB’s authority.

• Consumer Outreach 

The CFPB launched its website in early February.  The site's focus on social media backs up Elizabeth Warren's stated goal of hearing from consumers as the agency is under development.   On the not-so-welcoming side, the site features a very large badge and the phrase "Welcome to the Bureau."   The site states that:

The central mission of the Consumer Financial Protection Bureau (CFPB) is to make markets for consumer financial products and services work for Americans—whether they are applying for a mortgage, choosing among credit cards, or using any number of other consumer financial products.

• Warning Shots

The site also refers to the CFPB as a "neighborhood cop on a beat."  Peggy Twohig, the "Non-Bank Supervision Team Lead," described her unit's focus as follows:

Many companies other than banks provide consumer financial products and services. These nonbank companies include mortgage lenders, mortgage servicers, student lenders, payday lenders, credit bureaus, and debt collectors. Nonbank financial companies can have a huge impact on consumers, but, unlike banks, they have not been subject to regular Federal reviews to make sure they play by the rules. My team is planning a new Federal supervision program to oversee these companies. When banks and nonbank companies are subject to similar Federal oversight, consumers across the entire marketplace will be better protected

In Richard Cordray's first interview since arriving to set up the CFPB's enforcement operations, Jean Eaglesham of the Wall Street Journal reports that Cordray suggested he will use the same aggressive approach that he was known for in his previous job as Ohio's attorney general. Last year, the 51-year-old Mr. Cordray described the foreclosure practices used by companies now under a nationwide investigation as "a business model built on fraud."

While the hospitality industry seems to be rebounding, financing for new hotel and shared ownership projects is still not easy to come by.  That’s why Eliot Brown’s recent article in the Wall Street Journal caught my eye. 

The EB-5 Program (a/k/a “The Million Dollar Green Card”)

WSJ reporters Brown and Lynnette Khalfani-Cox aren’t the only ones who have been writing about the EB-5 Program.  Some web sleuthing indicates that some other prominent news outlets have been reporting on the “Million Dollar Green Card” fairly regularly since the beginning of the Great Recession.

Update:  Robert Frank at the Wealth Report also recently wrote about this program 

In a nutshell, the EB-5 Program allows citizens of foreign countries to obtain a 2-year conditional US immigrant visa based on an investment made in the United States.  In order to qualify, the investment must create 10 new full-time jobs in the United States.  Generally, the investment must be in the amount of $1 million, but this amount may be decreased to as little as $500,000 depending on the economic conditions of the area in which the business would operate.  Passive investment (i.e., ownership of real estate) would not qualify even if the job creation criteria was somehow satisfied.  After two years, the conditions on the visa can be lifted and the foreign citizen and his/her family would then become lawful permanent residents of the United States.

Of course, the EB-5 Program rules are much more complicated than summarized above, and the number of visas granted are limited to 10,000 annually.  In addition, the EB-5 Program expires in 2012 unless reauthorized.  Given some reported abuses in the program, reauthorization may be predicated on some significant changes.    

Application to the Hospitality Industry

A look at the projects sponsored by EB-5 Regional Centers indicates that several, if not most, are looking to attract EB-5 funds for hotel and resort development.  There is even something called the EB-5 Vacation Club.

I have worked with similar programs in the Caribbean, and its striking how they can alter the structure and marketing of a development project.  At a very basic level, it’s obvious that “passport” investors are making investment decisions on criteria other than the core business plan.  As we advised in a previous post, these are the type of investors a business (and its primary investors) may not appreciate down the road, especially if things don’t go as well as planned.  Investment documentation must specifically plan for and protect against this inherent risk.

Developers also need to consider the passport investor’s timeline.  While the business may need at least 3, 4 or 5 years to reach stabilization and profitability, the passport investor may only want to hold his/her investment for the minimum period required by the applicable program.  After that, it’s time to cash out.  Funding such requests could prove debilitating.       

In the shared ownership context, developers need to consider at least two other issues if marketing through “passport” programs: 

• Passport investors will typically look to cap any additional financial outlays after the initial investment.  Thus, these investors may look for predictability (read: guarantees) with respect to ongoing assessment obligations.
• If passport/residency rights are the primary purchase driver, a passport investor may be more motivated to resell his/her ownership interest immediately after fulfilling the program’s investment holding period.  Presumably, resale pricing may reflect a discount equal to the perceived value of the passport/residency rights received.  This scenario could present unwanted competition for the developer’s sales program, especially in larger developments where sell-out may take a number of years. 

I was at the Americas Lodging Investment Summit in San Diego a couple weeks ago. ALIS is the lodging industry’s first major investment conference of the year and is typically a good indicator of the mood and concerns of many owners, operators and lenders.

Two years ago, the feeling at ALIS was gloomy, perhaps bordering on panic. Last year, many attendees and panelists cautiously expressed opinions that the worst of the industry depression was over, but were unwilling to go so far as to say an upswing was in motion. This year, many top industry executives and consultants were boldly predicting that 2011 is going to be known as a year of strong recovery.

The overall vibe I felt from most attendees was that while occupancy and rate performance should continue to improve, questions remain on how robust the transactions market will be and when new development will begin to return. While the last two years were obviously difficult for the hospitality industry, most owners and operators with whom I spoke finally feel optimistic about the year ahead. While none are predicting the type of prosperity and deal activity of 2005-2007, many believe that 2011 will be an interesting year filled with opportunity in nearly every segment and every market that has seen gradual but consistent upturns in the past six to nine months.

Many at the conference expect that most of the activity will be forced sales as owners give up or fail in their attempts to keep trouble properties afloat. There is also expected to be an uptick in sales as the result of REITs, institutional investors and investment funds needing to place the cash that they have raised over the past year or two. Jones Lang LaSalle Hotels, for example, has predicted that hotel transaction volume will reach up to $13 billion in the Americas region in 2011 and the United States will be one of the most active hotel transaction markets globally in 2011.

According to the current schedule, the Consumer Financial Protection Bureau will absorb a significant portion the consumer protection functions (research, rulemaking, guidance, supervision, examination and enforcement) of the Federal Reserve, the FDIC, the FTC, the NCUA, the OCC, the OTS and HUD as of July 21, 2011.  Elizabeth Warren, who is overseeing the establishment of the CFPB, has said she wants the agency to “fundamentally remake the consumer credit system, dramatically simplifying it.”  

Curious as to what “simplifying” would mean, lenders (especially those providing purchase money financing) have been closely scrutinizing how the CFPB will be organized and staffed. Some insight on these questions is slowly leaking out.

   Organization

According to a draft skeleton organizational chart released by the Treasury, the CFPB would have 5 or 6 separate branches focusing on education, enforcement, operations, legal matters and external affairs.  Of note:

• The education branch would be devoted to “financial education and consumer experience,” with teams focused on specific populations (i.e., the elderly, military service members and students).  
• The enforcement branch would have a separate team supervising “non-bank financial institutions,” a category that would include those who primarily sell nonfinancial products or services but are also “significantly” engaged in the extension of purchase money credit.  The scope of this category may not be known until the CFPB and the FTC define the term "non-depository covered person" sometime before mid-2012.

    Staffing

The big question is who will run the powerful new agency.  The Wall Street Journal is reporting that a search is underway to identify an "acceptable" director of the CFPB - one presumably not named "Warren."  Until the head of the CFPB is named, attention is focused on who will fill out the lower level, but still potentially influential, positions:

• Richard Cordray will lead the formation of the enforcement branch.  As the Ohio Attorney General, Cordray collected over $2.5B is settlements from AIG,  Marsh & McLennan, Bank of America and Merrill Lynch.  According to Marx Sterbcow at the RESPALawyer Blog, Cordray has reputation for being a staunch advocate for consumer rights against financial services companies who break the law.  
• Holly Petraeus will reportedly head up the agency's efforts to protect military families from abusive lenders.  Ms. Petraeus, the wife of General David Petraeus, has argued that extra consumer protections are necessary to protect military service members from high pressure sales tactics that trap military families into expensive loans.
• Leonard Chanin will oversee the writing of new rules for consumer products. Chanin was previously the deputy director of the Federal Reserve Board's Division of Consumer and Community Affairs and is a founding member of the American College of Consumer Financial Services Lawyers.
• David Silberman will lead the bureau’s card-markets division.  Silberman served as deputy general counsel of the AFL-CIO when it first began the AFL-CIO credit card program and began his legal career as a law clerk for Supreme Court Justice Thurgood Marshall.
• Steve Antonakes, the Commissioner of Banks for the Commonwealth of Massachusetts for the past seven years, will lead depository supervision and Peggy Twohig, formerly with the Federal Trade Commission and currently serving as the Treasury's Director of the Office of Consumer Protection and Policy Lead for the CFPB implementation team, will lead non-depository supervision.