Coronavirus: Legal Perspective on the Impact on the Hospitality Industry

by May 19, 2020Covid-19, Hotel Operations

The hospitality industry across the world has been severely impacted by the proliferation of novel coronavirus (“Covid-19”), a disease termed as a pandemic by the World Health Organization. Covid-19 is unprecedented in that it is very easily transmissible and has by reason of international travel affected such a large number of countries as has never been seen before. Given social-distancing norms, followed by lockdown and business suspension orders consequent to COVID-19, the hospitality industry has been severely impacted. In India, since March 25, 2020, all hospitality services were suspended with the exception of establishments accommodating tourists and persons stranded due to lockdown, medical and emergency staff, air and sea crew or establishments being used or earmarked for quarantine facilities. While no relief measures have yet been announced by the Government to aid the ailing industry, certain Government directions have a direct impact on the hospitality industry. The impact of the business suspensions, falling demand and Government advisories need to be seen through the lens of the rights and obligations of hotel owners and their contractual arrangements. In this paper, we seek to cover certain headline issues resulting from the manifestation of COVID-19. 

Force Majeure, Act of God and Impact on Hotel Contracts

The key issue under most hotel contracts (be those with operators or vendors) is examining whether such contracts provides for a force majeure provision and whether COVID-19 is covered under such provision. Relief under force majeure provisions is only available if the relevant event is encompassed within the definitions and subject to the conditions as specified in contract. COVID-19 could be covered  under the head of ‘epidemic’. The lockdown or business suspension orders, on the other hand, would fall under government actions. Whilst most hotel management agreements with international operators cover epidemics and pandemics specifically, several other contracts only refer to Acts of God. Traditionally, courts in India have held an Act of God signifies the operation of natural forces free from human intervention, such as lightening, storm etc. It is arguable whether COVID-19 would be considered as an act of God. Government restrictions are usually covered under a separate head under force majeure. However, Government restrictions have followed the advent of COVID-19. Hence the time of commencement of force majeure poses an important question, since reliefs are only for the period of its subsistence.

Usually, in the case of management agreements (HMAs), the operator seeks to invoke force majeure, as its ability to operate a hotel in accordance with its self-imposed brand standards is impacted. Further, force majeure usually excuses the operator from its performance test. However, after the construction phase, it would be difficult to argue that the owner’s obligations are affected in any manner.

There needs to be a causal link between the force majeure event and the obligations claimed to require  suspension. Without such link, most contracts would not provide relief. Payment obligations are the hardest to seek relief for as the measure is not commercial hardship but impossibility of performance.

Mitigating Measures

Most contracts require a party claiming relief of a force majeure to mitigate the impact of a force majeure. In the absence of such provision, there is no duty to mitigate. However, even in such absence, where the parties are subject to certain performance standards or standards of care, an obligation to mitigate could be imputed. HMAs have standards of operations varying from obligations to act as prudent operators, aiming to achieve long-term profitability and in certain cases, to also act as an agent of the operator. In our view, pursuant to any of the aforesaid standards, an operator would have an implied duty to mitigate the impact of COVID-19 to the extent reasonably practicable. Purely commercial contracts, such as vendor arrangements, would typically not include such duties.

We have observed that many operators are re-visiting their business models and devising proposals which may help counter the impact to whatever extent feasible. Owner may seek further details relating to these and other mitigatory measures taken by operators and benchmark it against measures taken by similar operators, keeping in mind the fact pattern applicable to them.

Employment Issues

An unfortunate fallout of COVID-19 is the shrinking of the economy leading to job and wage losses. Central and State Governments have issued various advisories and orders directing employers to continue retaining employees despite closure of business and pay wages as if they were at work during the lockdown. This has a significant impact on businesses without revenues, many of which are now pushed to the brink of closures and insolvency.

There may be legal grounds for challenging such orders on the basis that the State Government orders are termed as advisories and are not binding, that the Central Government order shifts the economic burden to private parties (which is not clearly contemplated in the Disaster Management Act, 2005 (DMA)), and that there is no clarity in the manner of application of such laws. However, non-compliance of these orders issued under the DMA would expose businesses to penalties and in case of companies, those in charge, i.e. managers and directors would be at direct risk. Therefore, compliance, although burdensome, is recommended. It is pertinent to note these orders and advisories cover the period during lockdown, and at this stage there is no direction for post the lock-down period. Employers may look to contractual renegotiations or statutory procedures for lay-offs and retrenchments post lockdown, depending on manner of resumption of business.

A distinction may be made between line staff and those that have more supervisory or managerial roles, as the advisories and orders seem to suggest that they apply more to workers and not employees. Employees would continue to be bound by their employment contracts, and some may negotiate furloughs, deferrals or pay-cuts requiring agreement with the employees.  

There is, at this stage, no easy answer to questions arising out of the application of these orders. Businesses may want to weigh their commercial considerations as against public and media perception as well as social and political pressures.

Requisition of Premises

A common occurrence in India and world over is the requisition of hotels by government agencies for creating isolation or quarantine facilities or housing government staff, especially healthcare workers. The orders seem to be issued under the DMA, whereby the District Authority (as established for each State district under the DMA) can identify buildings and places which could, in the event of any threatening disaster situation or disaster, be used as relief centres or camps. Authorities also may, if they believe that any premises are required for rescue operations, issue an order requisitioning such premises for the limited duration of such requirement. Compensation would be payable to the owner. Some orders specify room rates that are payable by the Government, which may not be commensurate with the costs involved.

Additionally, various States have also implemented COVID Regulations under their powers in the Epidemic Diseases Act, 1897. under which they inter alia can designate any private building as a quarantine facility as a containment measure to prevent the spread of the disease in a defined geographic area. There are some technical issues relating to the enforceability of such orders. However, resisting them in the current scenario may not be possible.

These orders typically require certain manpower and services to remain available to the authorities. Recoupment of the costs would depend on the compensation payable by the authorities. Recourse in case of any shortfall seems unlikely.

Tax Implications

While the hospitality sector may fight this downturn by reducing their variable and overhead expenses until their revival, they would still need to continue incurring substantial fixed operating expenses (including payment of wages) which may be a challenge given the lack of revenue. Regardless of this, the sector continues to contribute in the fight against COVID-19 by offering their property for being used as quarantine facilities, serving meals, etc. Accordingly, it is the need of the hour that the Government recognizes the contribution of this sector and introduces appropriate subsidies/ exemptions perhaps to lower the fixed operating costs during the slowdown. Consumption based relief may not be of significance at this stage as there is no consumption. Some of these measures may be in the form of subsidy in license fee paid to the Government, including but not limited to liquor license, discount on electricity and water bills, interest free/ low interest working capital loans, deferral of property taxes, etc.

Hotels may also try to ensure minimal tax outgo on payments received by hotels for future bookings to preserve cash flows while at the same time being compliant with the law. The following may be borne in mind as regards the Goods and Services tax (GST) implications on cancellations:

  • For advance payments received in relation to bookings prior to the lockdown and for which GST has been paid in March, the following two scenarios may emerge:
    • The guests may request for cancellation of bookings made for stays during the lockdown period and would want the hotels to either refund the advance received or allow them to shift their existing booking to a later date. In such a case, as the Hotel would have already paid GST on the advance, the shifting of the date of stay would not impact the GST treatment by the hotels. However, if the hotels decide to refund the advance amount, they may opt  to file for a refund of the GST discharged in respect of such advances.  Alternatively, hotels may explore the option to adjust this amount against their output liability accrued in the month of March.
    • For cancellation of bookings falling after the lockdown period, hotels could consider not refunding the advance received or shifting the booking to a later date. In such a case, the advance received would be forfeited and tax may already have been paid on that. As GST would have already been paid on such amount, forfeiture of such amount could be construed as tolerating an act which is a supply exigible to GST at the rate of 18%. In some cases, hotels would have discharged the GST on the advance payment at the rate of 12% i.e. the rate applicable to supply of accommodation service with tariff under INR 7,500. This would result in additional GST liability of 6% (18%-12%) on the hotels.
  • While the due date of furnishing Form GSTR-3B for the months of February, March and April 2020 have not been extended, a relaxation has been provided in respect of the rate of interest leviable on delayed payment of tax for the said period. Taxpayers will be required to pay interest at a rate of 9% p.a. (and not 18% p.a.) which is payable post expiry of 15 days from the due date, on delayed payment of tax for the months of February, March and April, 2020. However, hotels may typically land up filing the GSTR-3B of the month of March, 2020 only by May 5, 2020.
  • Accordingly, the hotels may have received bookings in March, which have not yet been disclosed as an advance in the GST returns. In such cases, if the advance received by them is refunded, no GST implications would arise. However, if such amount is forfeited by the hotels, hotels may consider structuring such forfeiture amount in a manner to mitigate the eligibility of such amount to GST depending upon the treatment of the booking amount and the underlying documents created by the hotel. Only if the amount forfeited by the hotels is attributed to an underlying supply, would such amount be exigible to GST.

As for compensation, if any, payable to vendors on account of cancelation of orders, the same may be structured in an efficient manner such that the amount to be paid does not tantamount to supply and no GST is payable. Care should be taken that vendors do not book the amount forfeited by them in relation to specific underlying supply, in which case the transaction would typically not be treated as tolerating an act and no GST would be payable to the vendors. Even if the vendor decided to book the forfeited amount as tolerating an act and charged and collected GST at the rate of 18%, hotels should ensure that such vendors provide appropriate documents to equip the hotels to treat such expense to be in furtherance of their business and accordingly avail input tax credit of the GST paid.

Lending Covenants

Owners should carefully monitor their loan agreements. Even though payment defaults are unlikely (on account of the Government mandated moratorium), there is a strong possibility that the other covenants will have been breached (e.g. those relating to REVPAR and other performance related covenants). This could, post lifting of the moratorium, give a handle to lenders to accelerate the loan repayment. Coupled with a pledge, these instruments and strategies can be very well used by potential acquirers of hotels. If loans are assigned with all of this in mind, they become attractive assets for those looking to “loan to own”.

This article is by our guest authors Aakanksha Joshi, Partner, Economic Laws Practice and Sujjain Talwar, Partner, Economic Laws Practice

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