1:11-bk-10372•MSR Resort Golf Course LLC and MS Resorts Liquidating Trustee, LLC as Liquidating
MSR Resort Golf Course LLC and MS Resorts Liquidating Trustee, LLC as Liquidating
1:11-bk-10372Nysb10 août 2012
Texte intégral
UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK . . Chapter 11 IN RE: . . Case No. 11-10372 (SHL) MSR RESORT GOLF COURSE, LLC, . et al, . New York, New York . Tuesday, July 31, 2012 Debtors. . 4:09 p.m. . . . . . . . . . . . . . . . . BENCH RULING RE: TRIAL ON MOTION OF MSR RESORT GOLF COURSE, LLC, ET AL, FOR ENTRY OF AN ORDER ESTIMATING DAMAGES RESULTING FROM REJECTION OF THE HILTON MANAGEMENT AGREEMENTS AND AN ORDER AUTHORIZING REJECTION OF THE HILTON MANAGEMENT AGREEMENTS BEFORE THE HONORABLE SEAN H. LANE UNITED STATES BANKRUPTCY JUDGE APPEARANCES: For the Debtors: Chad J. Husnick, Esq. KIRKLAND & ELLIS, LLP 300 North LaSalle Chicago, Illinois 60654 Atif Khawaja, Esq. Eric F. Leon, Esq. KIRKLAND & ELLIS, LLP 601 Lexington Avenue New York, New York 10022 (Appearances Continued) Audio Operator: Electronically Recorded by Matthew, ECRO AudioEdge Transcription, LLC 425 Eagle Rock Avenue - Suite 201 Roseland, New Jersey 07068 (973) 618-2310 www.audioedgetranscription.com Proceedings recorded by electronic sound recording, transcript produced by certified transcription service. 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 1 of 45
APPEARANCES: (Continued) For GIC RE: Brian E. Greer, Esq. DECHERT, LLP 1095 Avenue of the Americas New York, New York 10036 Also Appearing: Michelle J. Vladimirsky, Esq. KASOWITZ, BENSON, TORRES & FRIEDMAN, LLP 1633 Broadway New York, New York 10019 APPEARANCES VIA TELEPHONE: For Waldorf=Astoria Management, LLC: David M. Neff, Esq. Brian Audette, Esq. PERKINS COIE, LLP 131 S. Dearborn Street, Suite 1700 Chicago, Illinois 60603 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 2 of 45
(Proceedings commence at 4:09 p.m.) 1 THE COURT: Good afternoon. 2 MR. LEON: Good afternoon, Your Honor. 3 THE COURT: All right. We are here this afternoon for 4 the purpose of reading a bench decision in the estimation trial 5 that we had earlier this month. 6 And I will apologize for subjecting to you all to a 7 lengthy, dramatic reading. As we discussed, my preference 8 probably would have been to prepare a written opinion in a case 9 like this, but timing is sensitive in this case; I want to get 10 the parties a decision quickly. 11 Let me just make sure everybody who's on the phone can 12 hear me. I suppose that most folks are listen-only, but I'm 13 particularly concerned with Hilton’s counsel, Mr. Neff. 14 MR. NEFF: (Via telephone) Yes, Judge. This is Mr. 15 Neff. I can hear you well. Thank you. 16 THE COURT: All right. This matter comes before the 17 Court on the April 24, 2012 motion of MSR Resort Golf Course, 18 LLC, et al., for entry of an order estimating damages resulting 19 from rejection of the Hilton Management Agreements, and an 20 order authorizing rejection of the Hilton Management 21 Agreements, which I'm going to refer to as "the motion." 22 In the motion, the debtors seek estimation of the 23 damages Hilton would sustain if the debtors reject three 24 management agreements. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 3 of 45
4 The management agreements relate to three properties: 1 one, the Arizona Biltmore Resort & Spa in Phoenix, Arizona; 2 two, the La Quinta Resort and Club PGA West in La Quinta, 3 California; and three, the Grand Wailea Resort Hotel & Spa in 4 Maui, Hawaii. 5 The Court conducted a trial on this matter over the 6 course of five days: June 27th, 29th, July 2nd, 3rd, and July 7 13 th . The Court at trial heard from five fact witnesses and two 8 experts on behalf of Hilton and one fact witness and one expert 9 witness on behalf of the debtors, in addition to materials 10 submitted by the debtors as part of their motion. 11 In connection with acquiring these three management 12 agreements, Hilton prepared a November 2005 investment 13 memorandum. That memorandum contained Hilton's then present 14 value of the future revenues from the three agreements at 15 roughly $260 million. That valuation of the three management 16 agreements was "predicated on realizing incentive fees," fees 17 that are provided for under certain circumstances in the three 18 management agreements. 19 Hilton assumed it would achieve incentive fees 20 starting in 2006, and would achieve the maximum contractual 21 incentive fee starting in 2010. At that time, in 2005, it 22 further assumed it would continue to receive the three percent 23 maximum incentive fee stream until the end of the contractual 24 term. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 4 of 45
5 For a variety of reasons that were discussed on and 1 off at the trial, Hilton did not receive the incentive fee 2 stream it anticipated. It has not, in fact, received any 3 incentive fees under these management agreements since 2007. 4 It does not seek the payment of incentive fees as part of the 5 damages sought in this proceeding. 6 Hilton's 2005 valuation was based on the full thirty- 7 year term, including the seven years from 2006 to 2012, for 8 which it has already received payment; and to date, it's 9 received $79 million in fees under the management agreements. 10 Turning to the three management agreements here, they 11 contemplate certain payments to the hotel manager. For 12 purposes of the Court's inquiry, these provisions regarding 13 payment are the same for the three agreements. 14 The first category of payments under the management 15 agreements is the management fee, set forth in Article 5.1 of 16 the management agreements. Under Article 5.1, the management 17 fee includes a base fee and an incentive fee that we've already 18 discussed. The management agreement defines the "base fee" for 19 management services as: 20 "An amount equal to two percent (2%) of gross 21 revenues." 22 The incentive fee, as mentioned earlier, is triggered 23 only if Hilton satisfies certain performance thresholds, which 24 are not at issue in this proceeding. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 5 of 45
6 The second category of payments contemplated by the 1 management agreements is something called the "corporate 2 overhead fee." Pursuant to Article 5.3 of the agreements, a 3 manager will receive a corporate overhead fee for corporate 4 overhead expenses that it incurs in connection with managing 5 the resorts. In the words of Article 5.3, the manager is 6 “reimbursed” for corporate overhead in the amounts equal to one 7 percent of gross revenues. 8 The third category of payments contemplated by the 9 management agreements is the so-called "group services 10 expense." Article 5.2 of the management agreements provides 11 for the manager to receive reimbursement for group services 12 expense in the amount of up to two percent for each of the 13 resorts' revenues. Group services expense is used to fund 14 marketing, advertising, reservations, and other promotional 15 services that the manager provides in managing the resorts. 16 Several other provisions of the management agreements 17 are relevant to this dispute, although they are not payments 18 that Hilton seeks as part of the proceedings. 19 The first of these is the Article 6 provision for 20 capital expenditures. Under that provision, the debtors -– 21 that is, the owners –- are obligated to contribute four percent 22 of gross resort revenue to fund necessary capital expenditures 23 at each resort. To the extent the manager believes funding of 24 additional capital expenditures is required beyond the four 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 6 of 45
7 percent, the management agreements require the manager to seek 1 approval from the debtors. If there is a disagreement over the 2 amount of capital expenditures needed, the manager may pursue 3 that dispute by putting the debtors on formal notice of a 4 contractual conflict and pursue a dispute resolution procedure 5 to resolve the matter. 6 Other relevant provisions in the management agreements 7 include a provision regarding the terms of the agreements, with 8 the term to run through 2024, with a ten-year option out to 9 2034. 10 The management agreements also have a provision 11 addressing termination. In that provision, the debtors have 12 the right to terminate the agreements without the payment of 13 any additional fee or premium if the manager fails to satisfy 14 certain performance requirements. Specifically, the debtors 15 may terminate the management agreements without penalty if, 16 after 2010 and for two consecutive operating years: 17 “(i) the GOP (gross operating profits) achieved by the 18 Hotel for each Operating Year is less than ninety percent (90%) 19 of the GOP set forth in the approved Annual Operating Plan for 20 such Operating Year.” And this has been referred to as the 21 gross operating profit test." 22 “(ii) the Annualized RevPAR (revenue per available 23 room) for the Hotel for each of such Operating Years is less 24 than ninety-five percent of the Annualized RevPAR of the 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 7 of 45
8 Competitive Set for each respective Operating Year.” And 1 that's been referred to as the "RevPAR performance test." 2 If the manager, here Hilton, fails to satisfy the 3 performance tests, and thus faces termination, it can make a 4 cure payment to the debtors to avoid termination and continue 5 managing the resorts. 6 The final provision that is relevant in the management 7 agreements for our purposes is a liquidated damages provision. 8 And that provides that if, after 2024, the debtors sell the 9 resorts and terminate Hilton as manager, Hilton is entitled to 10 a specified termination fee in the amount equal to the product 11 of the total management fee paid or payable by the manager for 12 the twelve-month period prior to the effective date of 13 termination, multiplied by a specified multiplier that varies 14 under the circumstances, and which we don't need to address in 15 this proceeding. 16 Turning now to the governing legal standard for this 17 dispute, the Court observes that each of the management 18 agreements is governed by the laws of the state in which the 19 subject resort is located. Accordingly, the laws of Arizona, 20 California, and Hawaii will govern the calculation of damages 21 to which Hilton will be entitled upon the rejection of each 22 respective management agreement. 23 These three states generally agree that, in a breach 24 of contract action, a plaintiff may recover the amount of 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 8 of 45
9 damages necessary to place it in the same position it would 1 have occupied had the breach not occurred. The usual recovery 2 for the breach of a contract is the contract price or the lost 3 profits therefrom. 4 To calculate lost profits, expenses are subtracted 5 from revenue. Only net profits, not gross profits, are 6 recoverable for breach of contract. These depend on the 7 particular transaction at issue, which dictates what expenses 8 need to be deducted from the gross profits to determine the 9 appropriate figure. 10 Arizona Courts have recognized that compensatory 11 contract damages will be awarded for the net amount of losses 12 caused and gains prevented. See Biltmore Evaluation & 13 Treatment Services v. RTS NOW, LLC, 2009 WL 223293, at *2 14 (Ariz. Ct. App. Jan. 29, 2009). Similarly, California Courts 15 have observed that damages are based on net profits, which they 16 have consistently defined as gains made after deducting the 17 value of labor, materials, rents, and all expenses, together 18 with the interest of the capital employed. See Electronic 19 Funds Solutions v. Murphy, 36 Cal. Rptr. 3d 663, 676 (Cal Ct. 20 App. 2005). Finally, Hawaii has recognized that a non- 21 breaching party may recover damages that arise naturally from 22 the breach, or that were in the contemplation of the parties at 23 the time of contracting. See Jones v. Johnson, 41 Haw. 389, 24 1956 WL 10315, at *3 (Haw. 1956). 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 9 of 45
10 The Court notes that the parties do not disagree about 1 what the applicable law is, although they strongly disagree 2 with how it should be applied in this case. Applying the 3 applicable law and relevant provisions of the management 4 agreements, the parties reach very different conclusions about 5 the proper measure of damages. 6 The Court notes that both parties use an expert to 7 provide a breakdown of the respective numbers on damages, as 8 well as an explanation of how each component is calculated. 9 Hilton's expert for this purpose was Roger Cline, and the 10 debtors' expert for this purpose was Thomas Morone. 11 On the one hand, Hilton contends it is entitled to 12 $334 million for rejection of these three management 13 agreements. Hilton's requested $334 million is broken into 14 four general categories: 15 First, it seeks damages of some $165 million for fees 16 under the three management agreements. These fees include a 17 base fee and the corporate overhead fee but do not, as 18 previously mentioned, include any damages for an incentive fee. 19 A large difference between the parties' calculation of 20 damages results from their use of different discount rates to 21 provide a current valuation for the worth of the payments that 22 Hilton would receive in the future. Hilton uses an eight 23 percent discount rate. 24 The second component of damages that Hilton seeks is 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 10 of 45
11 for group services expenses of approximately $38.9 million. 1 Third, Hilton seeks damages of approximately $120 2 million for so-called "brand damages." It describes "brand 3 damages" as the impact of the rejection of these three 4 management agreements on its Waldorf=Astoria brand. 5 Fourth and finally, Hilton seeks approximately $9.8 6 million in damages for losses relating to what it alleged to be 7 debtors' plan to expand the Grand Wailea Resort by some 300 8 rooms in the near future, thus purportedly expanding the 9 profits that Hilton would receive under that particular 10 management agreement. 11 Debtors, on the other hand, see things far 12 differently. They argue that Hilton is only entitled to 13 approximately $46 million in damages. Of the three categories 14 of damages sought by Hilton, debtors claim that Hilton is 15 entitled only to the first, the management fee, and that the 16 management fee should consist solely of the base fee. Thus, in 17 debtors' view, Hilton should get no damages for the corporate 18 overhead fee, group services expense, brand damages, and the 19 Grand Wailea expansion. 20 Moreover, debtors arrive at their figure of $46 21 million only after subtracting certain money for cure payments 22 that debtors contend Hilton will have to make for failing to 23 meet the performance test in the future at the Grand Wailea 24 Resort. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 11 of 45
12 I turn first to the issue of the management fees. And 1 in looking in that, the Court must first project the fees per 2 year that Hilton would earn under the management agreements and 3 reduce these profits by the expenses that Hilton would incur to 4 arrive at a profit margin. In doing that, one looks to the 5 total projected revenues at the Resorts as these revenues are 6 used to calculate the fees. 7 Mr. Morone and Mr. Cline's projections for the resorts 8 as, one witness put it, "quite close." Roger Cline, Hilton's 9 expert, projects approximately $14.6 billion in revenue. 10 Thomas Morone, an expert for the debtors, opines that the 11 projected revenue for purposes of the management agreements is 12 approximately $13 billion. 13 There are only two real differences between these two 14 different predictions of revenue. The first is the inflation 15 rate, where Mr. Cline uses three percent and Mr. Morone uses 16 2.5. 17 The Court concludes that the appropriate inflation 18 rate is 2.5. The Court finds that Mr. Morone reasonably relied 19 on historical data from the Bureau of Labor and Statistics. 20 That data shows the inflation rate for the past ten years at 21 2.4 percent. And he adjusted upwards to account for the 22 slightly higher twenty-year historical average of 2.6 percent, 23 resulting in his inflation rate of 2.5. 24 The Court rejects Mr. Cline's figure, which he has 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 12 of 45
13 adopted from an appraisal firm HVS, which is a standard 1 inflation rate that they use for hotel appraisals. Mr. Cline 2 also relies on a website called "forecastchart.com" to conclude 3 the appropriate rate is three percent. But he has not 4 submitted any evidence that forecastchart.com is a reliable 5 industry standard website. In any event, his reliance on 6 inflation rate used by another company without proffering any 7 evidence as to how it was determined or why it is appropriate 8 is insufficient to refute Mr. Morone's proposed inflation rate 9 based on historical data. 10 The second difference between the parties' predictions 11 is the level of capital expenditures to be made by the debtors 12 in the resorts. Mr. Cline assumes an eight percent 13 contribution by the debtors. In support of this number, Diane 14 Jaskulske, Hilton's witness, testified that Hilton averages 15 eight to ten percent of revenue annually for properties similar 16 in size and complexity as the resort. Matthew Bailey, Managing 17 Director of Grand Wailea, testified that four percent is simply 18 too low to maintain the operating standards under Hilton's 19 management agreement. 20 On the other hand, Mr. Morone utilizes a four percent 21 capital expenditure assumption, as per Article 6 of the 22 management agreements. Article 6 obligates the debtors to 23 contribute four percent of resort revenue to fund necessary 24 capital expenditures. Debtors argue that they have never 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 13 of 45
14 agreed to anything beyond the four percent, and that Hilton has 1 never formally requested any increase. 2 The Court finds that six percent is the appropriate 3 figure to use. The six percent, in fact, is derived from Mr. 4 Morone's testimony that the debtors have consistently spent six 5 percent, on average, on capital expenditures. The Court 6 rejects Hilton's eight percent as too high, given that Hilton 7 must follow certain procedures outlined in Article 6, in order 8 to receive additional capital expenditures funding beyond the 9 four percent reserve fund. And Hilton has never commenced the 10 dispute resolution procedure set forth in that article. 11 Hilton's position about the need for eight percent is 12 further undercut by the fact that Hilton, in its 2005 memo, 13 viewed the resorts to be in excellent shape before purchasing 14 these management contracts. And Mr. Bailey testified that, in 15 his view, the resort was in better shape today than it was at 16 the time of the purchase. 17 Moving on to the second component of damages, we turn 18 to the corporate overhead fee. The debtors' expert Mr. Morone 19 deducted the corporate overhead fee as a reimbursed expense, 20 while Hilton's expert Mr. Cline included the full one percent 21 of the corporate overhead fee in his calculation of lost 22 profits and deducted no expense incurred by Hilton in managing 23 the resorts. 24 In contending that the corporate overhead fee is a 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 14 of 45
15 reimbursement, rather than profit, debtors rely, among other 1 things, upon the language in Article 5.1 of the management 2 agreement, which expressly states that the corporate overhead 3 fee is to be reimbursed to the manager. They also note that 4 Section 1 of the management agreement states that the 5 management fee includes only the base and incentive fees, and 6 that the corporate overhead fee is never described as 7 "consideration" for Hilton's performance under the management 8 agreements. Debtors finally note that the liquidated damages 9 and termination provisions do not contemplate corporate 10 overhead fees being incorporated as liquidated damages in the 11 event of termination. 12 For Hilton's part, its expert Mr. Cline assumed no 13 expense for corporate overhead and payment of the full one 14 percent of profit. His conclusions were echoed by Hilton's 15 witness Diane Jaskulske, who testified that she was ninety-nine 16 percent certain that losing the resorts will not change "one 17 iota of what [is done in the] corporate office." Hilton's 18 corporate offices, she said, rarely assist directly in 19 providing services to the resort. 20 Instead, Hilton views corporate overhead fee as merely 21 a term that Hilton inherited when it acquired the management 22 agreements from the resorts' former manager KSL. As Hilton's 23 witness Ted Middleton explained, the corporate overhead fee is 24 simply viewed by Hilton to be analogous -- that is, the same -- 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 15 of 45
16 as the two percent base fee. 1 Based on all the evidence before the Court and the 2 applicable law, the Court concludes that Hilton is entitled to 3 the corporate overhead fee, provided that appropriate 4 deductions are made for expenses. Even though the management 5 agreements do not include the corporate overhead fee as part of 6 the management fee, there is no dispute that the fee would have 7 been earned had the debtors not rejected the Hilton Management 8 Agreements. 9 Further, Section 5.3 does not state that the corporate 10 overhead fee is reimbursable or subject to a cap like 11 reimbursable expenses. The management agreements only provide 12 that Hilton is to receive one percent of gross revenues. 13 While the debtors argue that the termination provision 14 is persuasive, the termination provision reflects an agreement 15 between the parties as to the amount that the debtors would 16 have to pay at a much later date to terminate the agreements, 17 as opposed to proof of actual damages. And those items are not 18 necessarily the same. See, e.g., Vrgora v. Los Angeles Unified 19 School Dist., 200 Cal. Rptr. 130, 135 (Cal. Ct. App. 1984), 20 explaining that liquidated damages are not necessarily a 21 proximation of actual damages suffered. See also Pima Sav. and 22 Loan. Ass'n v. Rampello, 812 P.2d 1115, 1118 (Ariz. Ct. App. 23 1991), explaining liquidated damages need not approximate 24 actual loss. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 16 of 45
17 However, the Court finds that Hilton's 2006 10-K form 1 is persuasive in suggesting that Hilton does incur additional 2 annual overhead expenses when adding new properties to the 3 portfolio. Indeed, the Court rejects as incredible the 4 testimony of various witnesses that there is no corporate 5 overhead associated with these resorts, which all parties 6 describe as "iconic," and indisputably far more complex than a 7 typical hotel managed by Hilton. 8 As to the exact measure of these corporate overhead 9 expenses, the Court will use Hilton's own estimate of such 10 expenses in its 2005 internal memorandum, which was prepared 11 before purchasing these management agreements. That memorandum 12 calculates its expected cost of managing the resorts at .25 of 13 revenues, or 8.33 percent of a three percent base management 14 fee. 15 The Court rejects as self-serving the only other 16 evidence of the actual amount of corporate overhead, which was 17 an estimate prepared by Hilton's treasurer solely for the 18 purpose of this litigation. 19 The Court now turns to the applicable discount rate. 20 A discount rate must be applied to calculate the present value 21 of future payments owed to Hilton under the management 22 agreements, to account for the time value of money and the 23 financial risk of the fee stream. See In re Chemtura Corp., 24 448 B.R. 635, 673 (Bankr. S.D.N.Y. 2011). 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 17 of 45
18 In Chemtura, Judge Gerber noted that the discount rate 1 should be calculated at the time the contract was entered into. 2 Chemtura, at 677. 3 "Existing case law and common sense require that the 4 discounting to fix the damages award must reflect the 5 same payment risk insofar as the Court can accomplish 6 that as the original contract did." 7 Id. at 673. 8 The choice of an appropriate rate does not need to be 9 exact. See Jones & Laughlin Steel Corp. v. Pfeifer, 462 U.S. 10 523, 552-553 (1983), where the Court notes: 11 "We do not suggest that a trial judge should embark on 12 the search for delusive exactness." 13 The Court may choose a discount rate not proposed by 14 the parties. See In re 785 Partners, LLC, 2012 WL 959364, at 15 *5 (Bankr. S.D.N.Y. Mar. 20, 2012), holding that, since the 16 experts did not thoroughly explain their determinations of the 17 discount rate, the Court treated their opinions as the range 18 and selected an intermediate rate. 19 Although the weighted average cost of capital -- which 20 we'll discuss a bit more in a moment -- or the "WACC," is a 21 reasonable starting point in determining the proper discount 22 rate, the WACC must be adjusted to account for risk. See In re 23 M Waikiki, LLC, 2012 WL 2062421, at *4 (Bankr. D. Haw. June 7, 24 2012). 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 18 of 45
19 Here, Hilton argues for an eight percent discount 1 rate. It contends that the risk of the management agreements 2 at the time they acquired them were de minimis. It contends 3 that eight percent is the industry standard, and it's what 4 Hilton uses to value its own management fees contracts. It 5 notes that the base management fee here is less risky than 6 other revenue streams because it is paid first from the hotel 7 revenue and, thus, far less risky than fees that are a function 8 of hotel profitability. 9 One Hilton expert, Mr. Hennessey, testified that the 10 proper discount rate was 7.5 percent, based among a variety of 11 things, including: mortgage rates for full service hotels as of 12 April 2006; and the rate generally utilized for hotel 13 investments as of April 2006. He also considered the WACC at 14 the time Hilton acquired the resorts and adjusted it downward 15 to, in his view, achieves a discount rate applicable to the 16 hotel company's reliable income stream derived from base 17 management fees. In his report, he referenced a report by Bear 18 Stearns, which gave Hilton's WACC at 8.1 percent. He also 19 testified he looked at Bloomberg, which reported Hilton's WACC 20 at 8.7 percent as of December 31st, 2005, and 8.2 percent in 21 the first quarter of 2006. 22 Debtors again have a different view. Their expert, 23 Mr. Morone, applied a 13.6 percent discount rate to the Arizona 24 Biltmore and the hotel in California, and a 14.6 percent 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 19 of 45
20 discount rate to the Grand Wailea. He calculated Hilton's 1 overall weighted average cost of capital; the WACC, as of the 2 beginning of 2006, to be 10.6 percent. He noted that Mr. 3 Hennessey testified that Bloomberg's reported WACC of 8.7 4 percent relied on what's called a "beta" that was a default of 5 one percent; or, as Mr. Morone used, a beta of 1.29. 6 Beta is one of the components in calculating the WACC 7 for any company and measures that company risk in relation to 8 the rest of the market. Mr. Morone testified that the 1.29 9 beta is appropriate because Hilton stock was riskier than the 10 market as a whole, and for that he cited debtors' expert Derek 11 Pitts, who submitted an affidavit with the debtors' motion. 12 Mr. Morone adjusted Hilton's WACC to account for 13 property-specific risks, as the WACC reflects aggregate risk of 14 Hilton's entire diversified portfolio of management agreements, 15 relying on something called the "Ibbotson's Size-Risk Premium," 16 Mr. Morone adjusted the WACC to reflect specific risks, such as 17 the size of the resorts, the brand, and the volatility as to 18 the Grand Wailea. He noted the Grand Wailea's additional risk, 19 in his view, included the remote location, the dependency on 20 air travel, the dependency on group travelers, and natural 21 conditions. 22 Based on the credible evidence and the applicable law, 23 the Court starts off by adopting the WACC used by Mr. Morone. 24 The difference between Bloomberg's WACC of 8.7 percent 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 20 of 45
21 and Mr. Morone's determination is that Mr. Morone used a beta 1 of 1.29, as opposed to a beta of one. The affidavit of 2 debtors' expert Derek Pitts provides support for the assertion 3 of using a beta of 1.29; and in fact, Mr. Pitts' affidavit 4 provides the only real analysis of beta in this case. 5 Using that beta and information from Hilton's own 10- 6 K, I reach the conclusion that Hilton's WACC at the time of 7 entering these management agreements was 10.6. 8 Mr. Hennessey opined that Hilton's WACC was 8.1, but 9 based his finding upon an internal Bear Stearns estimate 10 published in December 2006, almost a year after Hilton acquired 11 the resorts. 12 I also note that Hilton's expert makes reference to 13 Bloomberg's WACC. There was discussion at trial that Bloomberg 14 apparently uses a default beta of one. It was unclear from the 15 testimony -- indeed, no one seemed to know -- if that default 16 of one was used by Bloomberg in all instances for Hilton or 17 even in all instances for all companies. And as no party has 18 provided any explanation of the basis for using that default of 19 one here, the Court instead relies on the 1.29 beta, for which 20 analysis has been provided by Mr. Pitts. 21 On the one hand, Hilton has failed to establish that 22 the management agreements lack any risk, and that its eight 23 percent rate that it applies to all acquired management 24 agreements is sufficient to discount its future fees upon 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 21 of 45
22 rejection. Indeed, credible evidence has been presented 1 showing that these iconic resorts are exposed to unique risks 2 that make their revenue streams more volatile than a typical 3 Hilton property, supporting an upward adjustment of the WACC, 4 which represents the riskiness to Hilton's business as a whole. 5 Thus, the Court rejects the notion that the same risks apply to 6 these resorts as apply to the operation of one of Hilton's 7 Hampton Inns. 8 On the other hand, the debtors have failed to persuade 9 the Court that the attendant risks are as high as they claim. 10 There is credible evidence that the management fees here, taken 11 from gross revenues, rather than profits, are a less risky 12 source of revenue for Hilton than many of Hilton's other 13 revenue streams and other revenue streams at the resort. 14 For all these reasons, the Court will adjust the WACC 15 for the Arizona Biltmore and the La Quinta upward by one 16 percent, to arrive at a discount rate of 11.6. And this is to 17 account for the attendant risks identified by Mr. Morone and 18 discussed by Mr. Pitts. 19 The Court will adjust the WACC for the Grand Wailea by 20 two percent upwards, rather than one percent, to reach a 21 discount rate of 12.6, based on the aforementioned attendant 22 risks, plus additional risks unique to the Grand Wailea that 23 were discussed at the trial, and that have been mentioned 24 previously, including its location. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 22 of 45
23 The one additional percent increase is also 1 appropriate to account for the possibility that the Grand 2 Wailea may fail the performance tests over the life of these 3 agreements. The credible evidence was that there have been 4 real economic struggles in the recent performance of the Grand 5 Wailea, which is perhaps the most iconic, and thus most unique 6 of these three resorts. These struggles have been evidenced by 7 various metrics that Hilton itself prepared, rating performance 8 at the resort. These difficulties no doubt have been 9 influenced by the current economic downturn and Grand Wailea's 10 location and unusual dependence on group bookings for success, 11 bookings that are incredibly sensitive to the economy. 12 Such an adjustment for risk of termination has been 13 recognized by the courts. See M Waikiki, 2012 WL 2062421, at 14 *4-5, adjusting the WACC upwards to account for performance- 15 based termination risk. See also Pet Food Express Ltd. v. 16 Royal Canin USA, Inc., 2011 WL 1464874, at *12 (N.D. Cal. 17 2011), noting that the failure to reduce damages due to 18 uncertainty of lost profits towards the end of an agreement 19 ignores the contingency in the agreement that would have 20 allowed a defendant to terminate the agreement prior to the end 21 of the term for plaintiff's failure to perform its contractual 22 duties and obligations. 23 The Court now turns to the related issue of cure 24 payments. Debtors' expert Mr. Morone deducted some $7 million 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 23 of 45
24 in cure payments because he contends that Hilton will fail the 1 performance test and will need to make cure payments on two 2 occasions. First, in his view, it will fail in 2013 and '14, 3 and because the debtors can terminate the contract, Hilton will 4 need to make a cure payment of some $6 million. As to the 5 second instance, based on a so-called "Monte Carlo Analysis," 6 Mr. Morone concludes that Hilton will again fail the 7 performance test as to the Grand Wailea in 2031, prompting a 8 second cure payment of almost a million. 9 Mr. Morone believes that both these cure payments 10 should be deducted from Hilton's profits. 11 The Court rejects the debtors' arguments as unduly 12 speculative for several reasons. First, while the Court agrees 13 there is a risk that Hilton will fail the performance test at 14 the Grand Wailea, that failure has not been shown to the degree 15 of certainty so as to make it appropriate to deduct cure 16 payments from Hilton's profits. As already discussed, this 17 risk of failure should instead be accounted for in application 18 of the discount rate for the Grand Wailea. 19 Indeed, in reaching that conclusion, the Court notes 20 that the performance test here has been described as fairly 21 easy to satisfy by some observers. And while I won't go that 22 far, I do note that Hilton's operating requirements are based 23 in part on Hilton Resorts' annual operating plan that it itself 24 prepares. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 24 of 45
25 Additionally, the Court notes that the Monte Carlo 1 Analysis is unduly speculative. Mr. Morone himself conceded 2 that he was unaware of its use in projecting future failure in 3 hotel management contracts. Indeed, the Court notes that the 4 prediction that Hilton will fail in 2031 seems to be at odds 5 with Mr. Morone's approach of only estimating revenues out for 6 ten years because he found predictions after ten years not to 7 be sufficiently reliable. I turn next to group services 8 expenses. Hilton seeks some $38 million, almost $39 million, 9 in damages stemming from lost group services expenses in the 10 event the management agreements are rejected. This figure is 11 comprised of two components. The first is some $17 million in 12 the net present value of lost group services expense, and the 13 second is some $21.7 million in so-called "key money." 14 The management agreements define group services 15 expenses as each hotel's: 16 "cost for participation in the group services 17 (including reasonable corporate overhead related 18 thereto) as determined in accordance with Section 5.2, 19 excluding reimbursable expenses which shall be charged 20 separately." 21 Group services includes services and facilities 22 relating to advertising, marketing, promotion, publicity, 23 public relations, and group sales services, for all 24 Waldorf=Astoria Hotels and Resorts, as well as any additional 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 25 of 45
26 program or group benefit such as the Hilton HHonors program, 1 that are provided to all managed hotels. Group services 2 expense are capped at two percent of resort revenue and are 3 distinct from the corporate overhead fee. 4 Hilton argues that the group services expense was 5 expressly provided for in the management agreements; and thus, 6 damages relating to them were foreseeable at the time of 7 contracting. Hilton states that the brand fund that 8 Waldorf=Astoria is currently operating operates at a loss, and 9 that Hilton subsidizes it already, and that Hilton would have 10 to self-fund the amounts formerly contributed to maintain the 11 same level of brand support and marketing for the 12 Waldorf=Astoria brand. Hilton believes that this funding will 13 have to continue until Hilton completely replaces the amount of 14 group services expenses previously contributed by the Hilton 15 Resorts, which its primary expert estimates will take at least 16 five years. 17 In addition to the group services expense itself, 18 Hilton seeks to recover over $21 million in so-called "key 19 money," which it alleges are payments that it will need to make 20 to obtain additional management agreements to replace the ones 21 that it would lose and therefore, to replace the lost group 22 services expense. Key money represents funds that a management 23 company may be required to pay a hotel owner to obtain those 24 management rights. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 26 of 45
27 For their part, the debtors argue that the group 1 services expenses exceed the cap established in the management 2 agreements, and accordingly should be reduced to the amount 3 actually expended, so that Hilton is no longer subsidizing the 4 difference. The debtors further argue that Hilton is also not 5 entitled to the approximately $17 million in group services 6 expense damages because the management agreements don't permit 7 recovery of such expenses, and that Hilton will replace any 8 lost group services by 2014, and that Hilton can simply elect 9 to avoid incurring any such damages. Finally, the debtors 10 assert there is no basis for Hilton's request for the $21 11 million in key money. 12 Given the facts and applicable law, the Court grants 13 in part and denies in part Hilton's request for damages in 14 connection with group services expense. The language of the 15 management agreements contemplates the payment of group 16 services expenses for the costs incurred in providing group 17 services to the Waldorf=Astoria brand generally. 18 The evidence established that Hilton has used such 19 funds for their intended purpose. The mere fact that Hilton 20 may spend more than is required for that purpose for its own 21 business reasons is irrelevant. All that matters is that 22 Hilton seeks only to recover the fee provided for under the 23 management agreements, not any extra costs beyond that. 24 Moreover, there was no evidence at trial that Hilton intended 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 27 of 45
28 in the future to spend less on group services for the 1 Waldorf=Astoria brand than is contemplated by the management 2 agreements. 3 Relatedly, the Court concludes that Hilton's request 4 for payments of these fees for a five-year period represents an 5 appropriate exercise of its duty to mitigate its damages. See, 6 e.g., Shaffer v. Debbas, 21 Cal. Rptr. 2d 110, 114 (Cal. Ct. 7 App. 1993), as well as Shahata v. W Steak Waikiki, LLC, 721 8 F.Supp. 2d 968, 988 (D. Haw. 2010). 9 The Court notes that Hilton has sought some $17 10 million in group services expense, a number that has been 11 described to me as having been discounted to net present value. 12 While the Court awards group services expense, it notes that 13 the correct number may be different than the $17 million. 14 While the parties do not address this issue, the Court's prior 15 ruling on the discount rate presumably applies to this 16 component of damages; therefore, this number presumably should 17 be adjusted accordingly consistent with this Court’s earlier 18 ruling on the discount rate. 19 Moving on to the second aspect of Hilton's group 20 services claim, the Court rejects Hilton's request for the 21 payment of so-called "key money" for several reasons. 22 As an initial matter, the provision to pay key money 23 is nowhere mentioned in the management agreements, in stark 24 contrast to the group services expense itself. So it is very 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 28 of 45
29 hard to say the key money was within the parties' contemplation 1 at the time of contract formation as an appropriate measure of 2 damages, and these requested damages are particularly troubling 3 given that the amount of key money sought is in fact greater 4 than the amount of damages actually sought for group services 5 expense under the contract itself. 6 In any event, the evidence at trial was insufficient 7 to support Hilton's claim for key money damages. Hilton cannot 8 identify which hotel agreements this key money will be used to 9 acquire. Instead, Hilton's claim for recovery of key money is 10 not grounded on any specific facts, but rather on Mr. Cline's 11 professional judgment. 12 But Mr. Cline based his analysis, specifically the 13 twenty-five percent ratio assumption he used for calculating 14 key money, upon conversations with Ted Middleton, Hilton's Vice 15 President of Development. Middleton, however, later testified 16 that he had done no analysis of the amount of key money that 17 Hilton would be required to pay to replace the group services 18 expense payments, and was not aware of anyone else at Hilton 19 who performed such analysis. 20 Finally, the Court notes that Hilton itself concedes 21 that whatever management agreements it may one day acquire 22 could very well be management agreements that Hilton would seek 23 to acquire regardless of whether these management agreements 24 are actually rejected. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 29 of 45
30 So for all those reasons and the lack of evidence 1 supporting the necessity of key money payments, the Court 2 rejects that component of damages. 3 I now turn to Hilton's request for so-called "brand 4 damages." Hilton seeks approximately $120 million in damages 5 stemming from its alleged damage to Hilton's Waldorf=Astoria 6 brand. These damages purport to stem from the debtors' 7 termination of the management agreements and flow from the 8 theory that these properties are "iconic and irreplaceable," 9 which is a phrase that has been used often in this trial and 10 seems not to be in dispute. 11 Hilton argues that such damages were contemplated by 12 the parties when Hilton acquired the agreements in 2006, as 13 part of an effort to launch the Waldorf=Astoria brand. Hilton 14 believed the acquisition of these management agreements for 15 these three resorts would enable Hilton to generate additional 16 business, as well as credibility among investors and within the 17 real estate development community. 18 Hilton further alleges that the loss of the resorts 19 would contribute to tension among other Waldorf=Astoria owners 20 who have already been pressuring Hilton to expand and grow the 21 brand, particularly given that the resorts collectively account 22 for some twenty-five percent of the rooms comprising that 23 brand. 24 Hilton's determination of the amount in brand damages 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 30 of 45
31 is based on two separate analyses that focus on the time period 1 spanning from 2012 to 2034. The first estimate provides for 2 losses to the existing pipeline of Waldorf=Astoria properties 3 and any impact to the brand's future development program. 4 Utilizing this approach, Hilton estimates brand damages 5 totaling a hundred-and-twelve-some-odd million dollars. The 6 second methodology estimates the overall value of the 7 Waldorf=Astoria brand and determines that the brand will lose 8 56.5 percent of its value. Under that analysis, Hilton 9 estimates damages in the total amount of $128 million. Taking 10 the midpoint between these two figures, Hilton seeks damages 11 for brand loss in the total amount of $120 million. 12 The Court denies Hilton's request for brand damages. 13 Like the request for key money, the notion for brand damages is 14 nowhere contained in the management agreements. Instead, the 15 notion of protecting and growing the brand is covered by the 16 management agreements' group services expense, which are 17 damages that have been requested by Hilton and granted by the 18 Court. 19 Moreover, Hilton's request for brand damages is 20 fatally undercut by lack of evidence. Hilton's expert Roger 21 Cline set forth his proposed calculation of damages, presuming 22 that there will be damage to the Waldorf=Astoria name. But 23 other than Mr. Cline’s opinion, Hilton has offered no hard 24 evidence of damage to its business or business opportunities, 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 31 of 45
32 including growth and expansion. 1 For example, Hilton has not provided evidence that a 2 current hotel owner, potential hotel owner, or Hilton HHonors 3 client has presented any concerns about the impact of rejection 4 on the brand. Thus, there is no evidence that any current or 5 future owner would refuse to engage in business with Hilton, 6 would back out of a deal, or would even seek to receive reduced 7 rates. 8 In fact, Hilton's own witnesses testified that no 9 owner has made any indication to Hilton that they would pull 10 their property from Hilton if these three resorts were lost; 11 nor could Hilton's witnesses identify any perspective 12 Waldorf=Astoria properties that would refuse to join the brand 13 as a result of rejection of these management agreements, or any 14 co-branding opportunities that will be lost. Indeed, none of 15 the hotel management agreements contain provisions that would 16 enable a hotel owner a right to terminate its own agreement 17 with Hilton by virtue of the loss of these three management 18 agreements, or at least no witness was aware of any such 19 provision. Hilton has not offered any evidence establishing 20 that any new hotel will elect not to join the Waldorf=Astoria 21 brand because of the management agreement rejections. 22 Accordingly, the Court concludes that Hilton has not 23 shown such brand damage will occur with the reasonable 24 certainty required for being awarded by this Court. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 32 of 45
33 The Court recognizes that rejection here has not yet 1 occurred; and thus, this case is different than a normal breach 2 of contract case, where the parties can look back historically 3 at events. This inevitably may mean that it is harder for 4 Hilton to provide evidence of brand damages. 5 But the Court notes that this bankruptcy and rejection 6 proceeding have been the subject of media coverage, and the 7 debtors have made it very clear from the beginning of this case 8 more than a year ago that rejection of these management 9 agreements was a real possibility, and evaluating the 10 management agreements in this case for rejection was one of the 11 three cornerstones of the debtors' restructuring efforts. 12 Given the well publicized nature of these proceedings, the 13 Court cannot grant the very substantial brand damages sought by 14 Hilton without some real-world evidence of damage to the brand. 15 And relatedly, the Court notes that the brand damages sought 16 are more than thirty-five percent of the total damages 17 requested in this case. 18 In addition to the lack of concrete evidence from 19 Hilton's fact witnesses, there are difficulties with some of 20 the assumptions underlying the brand damages calculation. For 21 example, the brand damages sought assume a valuation of the 22 Waldorf=Astoria brand at some 2.265 billion, but that value is 23 contradicted by some of Hilton's own documents and public 24 filings, which set forth a different valuation. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 33 of 45
34 Furthermore, Mr. Cline's lost opportunities damages 1 calculation is based on an estimation that, notwithstanding the 2 rejection, Waldorf=Astoria will increase its number of hotels 3 by twenty-two in the near future, an aggressive assumption that 4 appears fundamentally at odds with Hilton's claim that the 5 Waldorf=Astoria brand would be harmed by rejection. And 6 indeed, his projection as to the brand's performance going 7 forward is similarly aggressive into the future, undercutting 8 the argument of brand damage. 9 Finally, Mr. Cline's measure of calculating damages is 10 premised upon the notion that the measure of damages is 11 directly correlated to the number of rooms lost. But that 12 notion is undercut by evidence at trial that there will be 13 times when a brand might lose a hotel from its group, and that 14 loss may not inflict any damage whatsoever to the brand. Mr. 15 Cline did not offer any limiting principle regarding his theory 16 of brand damages to reflect this fact. 17 The rejection of Hilton's brand damage claim is 18 consistent with the applicable case law. Applicable state law 19 generally holds that speculative contract damages cannot serve 20 as a proper legal basis for recovery. See Scott v. Pacific Gas 21 & Electric Company, 904 P.2d 834, 845 (Cal. 1995); that case 22 noting that it was a fundamental principle of contract law that 23 speculative, remote, imaginary, contingent, or merely possible 24 contract damages cannot serve as a legal basis for recovery, 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 34 of 45
35 and absent any definable loss, a party is entitled only to 1 nominal damages. See also McDevitt v. Guenther, 522 F.Supp. 2d 2 1272, 1287 (D. Haw. 2007); that case highlighting that, under 3 Hawaiian law, speculative damages are not recoverable on 4 actions arising under contract or in tort. See also Southern 5 Union Co. v. Southwest Gas Corp., 180 F.Supp 2d 1021 (D. Ariz. 6 2002); that case holding that a party cannot recover for lost 7 profit damages on the grounds it is too speculative to support 8 recovery. 9 Moreover, the Court notes that the States of Arizona, 10 California, and Hawaii recognize that damages must be proven 11 with reasonable certainty. Walter v. Simmons, 818 P.2d 214 12 (Ariz. Ct. App. 1991); that case putting the burden on the 13 plaintiff to prove damages stemming from a breach of contract 14 with reasonable certainty. See also Maggio, Inc. v. United 15 Farm Workers of America, 278 Cal. Rptr. 250, 264 (Cal. Ct. App. 16 1991); that case noting that damages for loss of profits may be 17 denied as "unestablished" or as being too uncertain or 18 speculative if they cannot be calculated with reasonable 19 certainty. See also Omura v. American River Investors, 894 20 P.2d 113, 116 (Haw. Ct. App. 1995), stating that the extent of 21 loss must be shown with reasonable certainty and cannot be 22 based on mere speculation or guesswork. 23 These principles about certainty are applicable to 24 situations where parties assert claims for lost profits 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 35 of 45
36 resulting from damage to plaintiff's reputation, and case law 1 from all three states reflect this. See, e.g., Dong Ah Tire & 2 Rubber Co., Ltd. v. Glasforms, Inc., 2010 WL 1691869, at *5 3 (N.D. Cal. 2010); that case holding that there was insufficient 4 evidence to support any award of damages for lost profits or 5 reputation restoration, and that lost profits must be proven to 6 be certain as to their occurrence and their extent. See also 7 Hi-Pac Ltd. v. Avoset Corp., 26 F.Supp. 2d 1230, 1237 (D. Haw. 8 1997); that case holding that plaintiffs cannot recover on a 9 claim that a defendant's breach of contract damaged the 10 plaintiff's reputation, and thereby resulting in lost profits, 11 because the plaintiffs were unable to identify or reasonably 12 calculate any specific lost sales or profits, and accordingly 13 failed to meet their burden. 14 Also instructive are this jurisdiction's decisions 15 relating to claims on reputation damages. Generally, the 16 standard to show loss of good will or reputation damages is 17 high. In ESPN, Inc. v. Office of Comm’r of Baseball, 76 18 F.Supp. 2d 416 (S.D.N.Y. 1999), for example, the Court held 19 that under New York law, in order to recover damages for loss 20 of good will, business reputation, or future profits, the 21 claimant must prove the fact of loss with certainty, and the 22 loss must be reasonably certain in amount. 23 The Second Circuit in Toltec Fabrics, Inc. v. August, 24 Inc., 29 F.3d 778, 781 (2d Cir. 1994), presented a three-part 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 36 of 45
37 test for recovery: 1 The first being that the claimant must show that there 2 was in fact a loss of good will that must be proved with 3 reasonable certainty. 4 The second being that claimant must present objective 5 proof of that loss. 6 And third, that the claimant must show that the loss 7 was caused by the opposing party's breach. 8 These two cases, while outside the jurisdictions at 9 issue in this proceeding, are instructive in how to value and 10 approach the issue of brand damages here. 11 Hilton relies particularly on two cases in support of 12 its contention that it is entitled to brand damage, but neither 13 case supports its position. 14 In Woolley v. Embassy Suites, Inc., 278 Cal. Rptr. 719 15 (Cal. Ct. App. 1991), the Court considered a request by a hotel 16 branding and management company for a preliminary injunction to 17 prevent a hotel owner from terminating the hotel management 18 agreements. The Court there declined to grant the injunction, 19 noting that computation of a damage award for the loss to 20 Embassy's reputation as a result of wrongful termination could 21 be adequately addressed through expert testimony. 22 Nothing in this case mandates or counsels the award of 23 brand damages here, however. 24 Second, Hilton cites to In re M Waikiki, LLC, 2012 WL 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 37 of 45
38 2062421 (Bankr. D. Haw. June 7, 2012). In that case, the Court 1 denied Marriott's request for damages to its reputation and 2 good will associated with the hotel owner's alleged breach of 3 Marriott's management agreement. The Court's holding was based 4 on its finding that Marriott presented no evidence of any 5 damage to the brand reputation. 6 Hilton argues that this case supports its position 7 because the Hawaiian Court stated that its holding was without 8 prejudice to the ultimate allowance of Marriott's claims. 9 However, this case does nothing more than support the Court's 10 conclusion that Hilton cannot recover such damages without 11 proof. 12 Finally, I turn to the last item of damages sought, 13 those relating to the potential expansion of the Grand Wailea. 14 Hilton argues that it will incur losses in the amount of some 15 $9 million in connection with the proposed expansion at the 16 Grand Wailea in the event the debtors reject the management 17 agreement. 18 In April 2012, the County of Maui granted approval of 19 a two-hundred-and-fifty-million-dollar expansion at the Grand 20 Wailea, which would add approximately 310 additional rooms and 21 increase the size of the resort from 780 to 1,090 rooms. Such 22 expansion has been contemplated as far back as 2005. 23 Hilton argues that this expansion, which could be 24 completed by 2017, would add tremendous value to the resort, 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 38 of 45
39 with Hilton estimating such value at over $255 million. 1 Specifically, Hilton believes that expansion will result in a 2 significant increase in gross revenues; and accordingly, base 3 management fee income to Hilton, once expansion is completed. 4 Termination of the management agreements would prevent Hilton 5 from reaping the benefits of expansion in the form of increased 6 fees. Hilton opines that, using a thirteen percent discount 7 rate, the net present value of Hilton's foregone base fees and 8 corporate overhead fees total some $9.8 million. 9 But the Court rejects Hilton's claim for damages 10 associated with a possible expansion of the Grand Wailea. 11 While the debtors have the right to expand the Grand Wailea, 12 the debtors presented testimony at trial that they have no 13 obligation, contractual or otherwise, to undertake the 14 expansion; they also assert that they presently have no plans 15 to expand the Grand Wailea; and third, that they have made no 16 commitment to do so. None of these assertions can credibly be 17 disputed. 18 I parenthetically note that one of Hilton's witnesses 19 briefly suggested that the debtors were contractually obliged 20 to maximize operations at the resort, and that this meant the 21 debtors were obligated somehow to move forward with this 22 possible expansion. That position, I conclude, is a wild over- 23 reach, based on the contract language at issue. 24 But in any event, turning back to the debtors' 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 39 of 45
40 position here, it's not surprising, given the facts. As 1 previously discussed, the trial was full of evidence regarding 2 the poor performance of the Grand Wailea. The debtors' witness 3 Thomas Shumaker described the approval here obtained by the 4 debtors as a right to expand and conceded that this right was 5 enormously valuable. But he credibly testified that any 6 potential expansion of the Grand Wailea must be viewed in the 7 context of the future performance of the resort, and that the 8 current performance of the resort was a real concern. He also 9 credibly testified that the approval here could be extended 10 out, so as to preserve the debtors' options and this valuable 11 right, while not committing to going forward with any 12 expansion. He and other witnesses noted that the debtors have 13 actually had a right to expand a smaller number of rooms on the 14 same property for some time and have not proceeded to go 15 forward with that expansion. 16 In sum, the debtors' mere consideration of expansion 17 is insufficient to entitle Hilton to damages here. See, e.g., 18 Greenwich S.F., LLC v. Wong, 118 Cal. Rptr. 3d 531, 553 (Cal. 19 Ct. App. 2010); that case concluding that: 20 "The existence of plans for development does not 21 supply substantial evidence that the development is 22 reasonably certain to be built, much less that it is 23 reasonably certain to produce profits." 24 And that any reliance on a real estate project that 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 40 of 45
41 may not occur in order to claim lost profits is "inherently 1 uncertain, contingent, unforeseeable, and speculative." 2 See also Vestar Development II, LLC v. General 3 Dynamics Corp., 249 F.3d 958, 962 (9th Cir. 2001); that case 4 holding that there is no way to evaluate, other than through 5 speculation, the profits of a prospective land purchaser on a 6 shopping center it would have built, had the purchaser been 7 permitted to purchase the parcel of land. 8 The Court also notes that Mr. Cline's damages 9 calculation as to the Grand Wailea expansion is somewhat 10 defective because it fails to account for the fact that such 11 expansion would negatively impact the Grand Wailea's 12 performance. It would do so by causing considerable disruption 13 to the resort for the period during which construction was 14 underway, and could result in potential lost business, required 15 discounting, and loss of good will among affected guests. The 16 debtors anticipate that the adverse effect on revenue and 17 earnings could last as long as two years. 18 Relatedly, the Court notes the evidence at trial that 19 group bookings typically have a provision that permits them to 20 cancel their reservation if there's ongoing construction, and 21 that such group bookings are crucial to the Grand Wailea's 22 economic success. 23 That concludes the Court's rulings on the motion to 24 estimate damages from rejection of these three management 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 41 of 45
42 agreements. Again, as I noted earlier, it's my normal 1 preference to provide a written decision to the parties, but 2 debtors explained the need for a quick resolution of this 3 dispute and requested a decision, if at all possible, by August 4 1st, 2012, which is tomorrow. The need for such an expedited 5 decision relates to the existing deadlines for an exit strategy 6 in this Chapter 11 case, either by plan or sale or some 7 combination of both. And those deadlines for an exit strategy 8 were the result of hotly contested hearings on exclusivity in 9 this case, a dispute that was resolved by agreement of the 10 parties on the timing for an exit strategy. And so I 11 understand the quandary faced by the debtors; and therefore 12 prepared this bench ruling. 13 However, this being a bench ruling and transcription 14 being what it is, I plan to review the transcript to ensure 15 that it accurately reflects my ruling; and therefore reserve 16 the right to amend it accordingly. So I'd ask the debtors to 17 order the transcript on an expedited basis, and I'll take a 18 look at it. And I also request that the debtors prepare an 19 order memorializing my ruling, and obviously consult with 20 Hilton's counsel on the appropriate language to do so. 21 So that didn't take quite an hour and a half; it was a 22 little shorter than my estimate, but that concludes my business 23 for the day. 24 Is there anything that any party needs to raise? 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 42 of 45
43 MR. LEON: No. I just wanted to take the opportunity 1 to once again thank Your Honor and your staff for accommodating 2 the parties, our schedule, and in particular the debtors' short 3 time constraints. It's very much appreciated on all sides. 4 And we also appreciate Your Honor's attention to this matter. 5 THE COURT: Absolutely. 6 Mr. Neff, is there anything you need to raise at this 7 time? 8 MR. NEFF: Your Honor, did you want the parties to 9 attempt to come up and try to quantify what the amount is? 10 THE COURT: Well, that actually was going to be the 11 next thing I was going to mention. If you noted, there is no 12 ultimate bottom-line quantification. That's because there are 13 many components to this that I was trying to get right, and I 14 was going to leave you all to do the math, particularly as to 15 the discount rate. 16 So yes, I think, it would be the appropriate subject 17 of discussion among the parties, in terms of memorializing the 18 ruling in an order. 19 MR. NEFF: Very good. 20 THE COURT: All right. Thank you. 21 Anything else? All right. 22 MR. LEON: Nothing for debtors. 23 THE COURT: Thank you. Have a good evening. 24 MR. LEON: Thank you, Your Honor. You, too. 25 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 43 of 45
44 MR. NEFF: Thank you, Judge. 1 (Proceedings concluded at 5:15 p.m.) 2 ***** 3 4 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 44 of 45
45 CERTIFICATION 1 I certify that the foregoing is a correct transcript 2 from the electronic sound recording of the proceedings in the 3 above-entitled matter. 4 5 6 7 S/ Coleen Rand August 1, 2012 8 Coleen Rand, AAERT Cert. No. 341 DATE 9 10 Certified Court Transcriptionist 11 12 AudioEdge Transcription, LLC 13 11-10372-shl Doc 1397 Filed 08/10/12 Entered 08/10/12 17:29:47 Main Document Pg 45 of 45
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