EB-5 and Tenant Occupancy Issue
EB-5 AND THE TENANT OCCUPANCY ISSUE
AS APPLIED TO HOTEL EMPLOYEES
By Catherine DeBono Holmes, Victor T. Shum and Stephen Yale-Loehr
The U.S. Citizenship and Immigration Services (USCIS) created a new controversy in the EB-5 immigrant investor world when it released a memorandum on February 17, 2012 concerning what it calls the “tenant-occupancy” economic methodology. According to USCIS, the tenant-occupancy methodology seeks credit for job creation by independent tenant businesses that lease space in buildings developed with EB-5 funding. According to a standard request for evidence (RFE) that many EB-5 regional center applicants received after issuance of the memo:
"USCIS has concerns that the attribution of certain direct jobs to the EB-5 investment may not be based on reasonable economic methodologies, and therefore do not demonstrate in "verifiable detail" that the requisite jobs will be created. Rather, contemporary economic methodologies appear to indicate that such jobs would more appropriately be attributed to the tenants themselves and not to the regional center because the demand for labor precedes the decision about where to house that labor as a general economic principle. For example, if a federal agency determined that additional federal employees needed to be hired to fulfill the agency's mission at a particular location, the federal agency would seek to hire the requisite number of employees and as part of that process, would also take steps to lease the appropriate physical premises to provide sufficient workspace for the new hires. In this instance, it is the federal agency that is creating the jobs through its decision to hire more employees, not the landlord who will ultimately lease the workspace to the federal agency."
USCIS has issued over 80 RFEs concerning the tenant-occupancy methodology in recent months. These RFEs articulate a new USCIS policy to discredit any employment creation from leases to tenants in many cases. Requests for evidence have even been issued with respect to hotel operations that do not have any leases or tenants. It may be that USCIS adjudicators view employees of a hotel management company that operates a hotel in the same light as employees of tenants of an office building or retail center. This view, however, does not reflect the reality of a hotel management agreement, which is far different from a lease of any form of real property.
A Hotel Management Agreement is Not a Lease. This article explains why a hotel management agreement is not a lease and why the employees of a hotel should be counted as the “direct” employees of the hotel operation. It may be helpful to non-hotel industry readers to know that two of the article’s co-authors been active in the hotel industry for many years and have negotiated thousands of hotel management agreements in the U.S. and worldwide with all of the major hotel brands as well as the independent “non-branded” hotel operators. This article is written for our friends in the EB-5 community to explain the nexus between the EB-5 investment and the job creation methodology, in the hope that it will shed light on this crucial issue for EB-5 financing of hotel developments.
A hotel management agreement is an agency agreement. A hotel management agreement is essentially an agreement between a principal, the hotel owner, and an agent, the hotel manager, under which the hotel manager undertakes to manage the hotel as the agent of the owner. In the case of a branded hotel management agreement, such as an agreement with Hilton, Hyatt, Marriott or Starwood, the hotel manager agrees to use its own name in the management of the hotel, whereas in the case of a non-branded hotel management agreement, the hotel manager does not use its own name in operation of the hotel. In either case, the duties of the hotel manager are essentially the same - to manage all aspects of the operation of the hotel as the agent of the hotel owner.
Hotel employees are always controlled by the hotel manager. Under a typical hotel management agreement, the hotel manager has very specific duties with respect to the operation of the hotel, including the duty to hire, train, supervise and fire employees of the hotel. The employees of the hotel may be either directly employed by the hotel owner, or employed by the hotel manager. In years past, hotel owners would often prefer that the hotel employees be directly employed by the hotel manager, in the belief that this would provide some insulation from liability for employment claims. However, the legal principles of joint employment in many jurisdictions could potentially result in hotel employees being considered joint employees of both the hotel owner and hotel manager. In either case, the hotel manager is typically responsible for all decisions with respect to the employees of the hotel. The hotel owner, even if it is the direct employer of the hotel employees, typically has little control over the hotel employees, other than owner approval rights over the executive staff of the hotel. The hotel manager generally controls all aspects of the employees of the hotel under the terms of the hotel management agreement.
The hotel owner is always responsible for all employee salaries and costs. Although the hotel owner does not control the work of the hotel employees, under the typical hotel management agreement, the hotel owner is the party responsible for all of the costs and expenses of operation of the hotel, including labor costs. These include salaries, wages and benefits, and any liabilities for employment related claims (harassment, discrimination, wage and hour violations, and the like). If the revenues from operation of the hotel are not sufficient to pay all of the costs of operation of the hotel, including the costs of employees of the hotel, the hotel management agreement typically provides that the hotel owner must pay such costs and indemnify and hold the operator harmless from such costs and liabilities. Practically speaking, this means the owner must make additional cash contributions into the hotel operating account to fund any shortfalls in the hotel payroll and related expenses of the hotel.
The hotel manager receives management fees and the hotel owner retains the net profits of the hotel operation. Under the typical hotel management agreement, the hotel manager receives a management fee, usually consisting of a base fee equal to a specified percentage of gross revenues of the hotel and an incentive fee consisting of some percentage of the net profits of the hotel, plus reimbursement for certain expenses of the hotel manager that are considered costs of the hotel, such as centralized marketing and purchasing services. The hotel owner retains all net profits from operation of the hotel, as well as all of the economic risks of ownership and operation of the hotel, including operating expenses in excess of hotel revenues. Because the hotel manager receives only fees and not profits of the hotel operation, the hotel management agreement typically provides that the hotel owner is required to indemnify the hotel manager for any losses it incurs in operation of the hotel, except in the case of the hotel manager's gross negligence or willful misconduct. Hotel owners are often surprised to find that even if a loss is caused by the hotel manager's negligence, the hotel owner is responsible to pay for the loss, unless it was caused by the hotel manager's gross negligence or willful misconduct.
The economic risks between a hotel management agreement and a lease are different. In comparison with a typical commercial lease, the relationship between a landlord and a tenant is quite different than that between a hotel owner and hotel manager. In a lease, the tenant pays rent to the landlord, and the tenant bears the economic risk of the business enterprise conducted on the premises. In a hotel management agreement, the hotel owner pays a management fee to the hotel manager, and the hotel owner bears the economic risk of the hotel enterprise. In a lease, the tenant employs its own employees and the tenant is responsible for all of the costs of employment, including salaries, wages and benefits. In a hotel management agreement, the hotel owner is responsible for all of the costs of the hotel employees, regardless of whether the hotel owner or the hotel manager is the employer of the hotel employees.
Hotels do not move from one location to another. A tenant of an office building or retail center can take a business enterprise to another location and conduct the same business. A hotel is a unique business enterprise that is a hybrid of a real estate investment and an operating business. As such, the building itself is part of the value of the hotel enterprise. The hotel owner can only preserve the value of the hotel enterprise by preserving and continuing to operate the hotel in its existing location. Even if a hotel manager terminates a hotel management agreement, the hotel owner can only retain the value of that enterprise by continuing to operate the hotel, if necessary by finding a new hotel manager. The hotel manager cannot move the hotel enterprise to a new location, because it is not the owner of the hotel enterprise, it is only a service provider to the hotel owner.
Hotel employees will often remain at the same hotel, even after a hotel management agreement terminates or the hotel is sold. Even when a hotel management agreement expires or otherwise terminates, the vast majority of the hotel employees will continue to work at the hotel under the next operator. In fact, the hotel management agreement will often provide that the hotel owner has a right to solicit the existing hotel employees to remain employed at the hotel. This would never be the case in a typical office or retail lease, where the employees would move with the tenant, or lose their employment altogether. Even if the owner sells the hotel, the new hotel owner usually rehires the hotel employees. As this experience demonstrates, the job opportunities created by a new hotel are long lasting.
When a new hotel is opened, it does not mean that the old hotel will cease operations or reduce the number of employees. When a new hotel is opened near an existing hotel, it is typical that the existing hotel will remain in operation, even though it may change hotel brands or hotel managers, and both hotels will still require a minimum number of employees to remain in operation. Therefore, a new hotel in the same area as an existing one will generate new jobs as opposed to shifting or relocating employees from the already existing hotel.
Conclusion: Hotel employees have a strong nexus to the hotel enterprise rather than to the hotel manager. For all of these reasons, the USCIS should view hotel employees as the employees of the hotel enterprise, regardless of whether their actual employer is the hotel owner or the hotel manager. The nexus between the EB-5 investment and job creation in the hotel context is so strong that it continues to exist regardless of whether the hotel owner or the hotel manager bears ultimate responsibility for employment.
 Catherine DeBono Holmes is a transaction and finance partner at Jeffer Mangels Butler & Mitchell (www.jmbm.com) with JMBM's Global Hospitality Group® and Chinese Investment Group™ and specializes in resort and hotel purchase and sale transactions, resort and urban mixed-use financing and development, hotel management and franchise agreements.
Victor T. Shum is a corporate and securities partner at Jeffer Mangels Butler & Mitchell (www.jmbm.com) in JMBM's Global Hospitality Group® and Chinese Investment Group™. He has advised clients on EB-5 matters since 1999 and assists hotel developers on EB-5 financing as well as public and private securities, mergers and acquisitions, cross-border issues, and other strategic business transactions.
Stephen Yale-Loehr (firstname.lastname@example.org) is co-author of Immigration Law and Procedure, the leading immigration law treatise, published by LexisNexis Matthew Bender. He also teaches immigration law at Cornell Law School and is of counsel at Miller Mayer (http://www.millermayer.com) in Ithaca, NY. He founded and was the first executive director of Invest In the USA (IIUSA), a trade association of EB-5 regional centers.
Copyright © 2012 Catherine DeBono Holmes, Victor T. Shum, and Stephen Yale-Loehr. All rights reserved.
 The February 17, 2012 USCIS memo on tenant-occupancy methodology issues does not appear to be on the USCIS web site. However, it is reprinted at http://blog.lucidtext.com/2012/02/17/economic-analysis-problem-revealed/.
 One example of the typical provision describing the relationship between a hotel owner and hotel manager reads as follows: "Subject to the provisions of this Agreement, Owner hereby engages Operator, and Operator hereby agrees to be engaged and to supervise, direct, and control the management, operation, and promotion of all aspects of the Hotel as the agent of Owner and as the exclusive operator of the Hotel during the Operating Term."
 One example of the typical provision describing the hotel manager's duties with respect to employees reads as follows: "Operator shall recruit, hire, train, pay, supervise and dismiss all Hotel Personnel and determine, prepare and implement all prudent policies and practices relating to all aspects of the Hotel, and train and supervise all Hotel employees for compliance with all such policies and practices…"
 While courts in different jurisdictions will apply varying tests to determine whether a joint employment relationship exists, the primary focus is on the economic realities of the relationship and whether there is some measure of control retained by the entity claimed to be a joint employer. It is beyond the scope of this article to discuss the tests used to determine joint employment status, other than to note that both a hotel owner and hotel manager can be determined to be joint employers of hotel employees, as a result of which both may have liability for wages, benefits and other claims made by hotel employees.
 One example of the typical provision describing the hotel owner's liability for all expenses of the hotel reads as follows: "Owner shall commit the financial and other resources necessary to permit the Hotel to be operated and maintained in accordance with the Operating Standard, and to pay all Operating Expenses and Capital Expenses of the Hotel in accordance with the Operating Plan and Budget and Capital Budget for the Hotel. If at any time during the Operating Term, Operator determines that the available funds in any Operating Account are insufficient to allow for the uninterrupted and efficient operation of the applicable Hotel in accordance with the terms of this Agreement, Operator shall notify the Owner of the existence and amount of the shortfall (a "Funds Request"), and the Owner shall deposit into the Operating Account the funds requested by Operator in the Funds Request.