New Development Regarding the Treatment of Hotel Revenues in Bankruptcy

A hotel generates revenues from providing lodging, food and drink and many services to hotel guests. When the hotel owner goes into bankruptcy, the lender who claims to have a lien on the hotel typically argues that all of the hotel revenues are the lender's "cash collateral" under ยง363(a) of the Bankruptcy Code. If the bankruptcy court agrees, then the owner/debtor (or trustee) may not use the cash collateral unless the lender consents or the court permits such use.

This article discusses whether, under case law in the Ninth Circuit (which covers California, Washington, Idaho, Nevada, Oregon, Montana and Arizona) and the 1994 amendments to the Bankruptcy Code's definition of cash collateral, at least some hotel revenues do not constitute "cash collateral."

The Days Inn Case

In June 1994, the Ninth Circuit held in the Days Inn case (In re Days California Riverside L.P., 27 F.3d 374 (9th Cir. 1994)) that only a hotel's room revenues may constitute cash collateral; revenues generated from food and beverage sales and other hotel services unrelated to room occupancy are not cash collateral. This ruling benefited hotel owners because a debtor may use non-cash collateral free and clear of the lender's lien and does not need the lender's consent to use the funds.

The 1994 Amendments

Effective October 22, 1994, the Bankruptcy Code's definition of cash collateral was amended to include "the fees, charges, accounts or other payments for the use or occupancy of rooms and other public facilities in hotels, motels or other lodging properties subject to a security interest."

Reconciling The Days Inn Case and The 1994 Amendments

A "hot" legal issue in the Ninth Circuit is whether the 1994 Bankruptcy Code amendments either overrule the Days Inn case (and require a court to find that all hotel revenues are cash collateral) or codify and embrace the Days Inn case's exclusion of certain hotel revenues from what constitutes cash collateral. This issue was litigated in 1996 in a California bankruptcy court. The judge ruled that hotel revenues for services the guest could receive outside the hotel (including food and beverage, room service and telephone revenues) are not cash collateral (consistent with Days Inn), while room revenues and revenues for services "related" to the hotel (such as parking fees and fees for using the hotel's health club or spa) are cash collateral.

In a brand new decision, the Ninth Circuit characterized the 1994 Bankruptcy Code amendments as clarifying the statutory definition of rents to include hotel room revenues. In re Hotel Sierra Vista L.P. 1997 WL205804, 97 Daily Journal D.A.R. 5439 (9th Cir. 4/29/97). By its characterization of the 1994 amendments the Ninth Circuit held in this new case that its Days Inn decision continues to apply. The Court remanded the case with direction to apply the Days Inn formula and to determine how much of the hotel's net revenues were and were not cash collateral.

While it is debatable whether the 1994 amendments are limited or designed to capture only a hotel's room revenues, this appears to be the law in the Ninth Circuit after the Hotel Sierra Vista decision. Thus, hotel owners have a powerful argument that the net proceeds attributable to a hotel's non-room revenues are not cash collateral. The bankrupt hotel owner may use such non-cash collateral free and clear of the lender's lien and does not need to obtain the lender's consent or court approval to use the funds. There are other limitations on the debtor's use of these revenues in the Bankruptcy Code and case law to prevent fraud or waste. Nevertheless, this issue remains paramount to both hotel owners in bankruptcy and secured creditors claiming a lien on the hotel revenues.