Lessons from troubles besetting listing of Eagle Hospitality Trust

SINGAPORE is a popular listing destination for real estate investment trusts (Reits) and business trusts - so much so that many foreign real estate asset owners choose Singapore as their listing destination.

One major foreign listing was that of Eagle Hospitality Trust (EHT) - an owner of hospitality assets in the United States.

EHT made its debut on the mainboard in May 2019 with an initial portfolio of 18 hotel properties. Within months of its listing, however, EHT began to disappoint investors. Negative reports emerged, and the value of its stapled securities fell.

Less than a year into its listing, EHT was suspended after one of its units defaulted on a loan. The trust is now in the process of liquidating various entities, and EHT will most likely need to be delisted.

Are there any lessons to be learned from EHT's problems? Robson Lee, a partner in Gibson Dunn's Singapore office and a member of the firm's mergers & acquisitions and capital markets practice groups, said EHT's case illustrates how the safeguards in the Singapore Exchange (SGX)'s listing regime have some limitations when it comes to trusts that are dependent on master lease arrangements.

The continued success of a trust that adopts a master lease arrangement will depend on the commitment and financial strength of the master lessees, Lee said. These master lessees would typically be affiliates of the trust's sponsor.

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Below, Lee addresses some of the key issues that have surfaced in the short time since EHT was listed and how investors can use this knowledge to make better investment decisions.

Q: Let's begin with the background of EHT. How was this trust structured?

A: EHT is a stapled trust comprising Eagle Hospitality Real Estate Investment Trust (EH-Reit) and Eagle Hospitality Business Trust (EHBT). The stapled trust structure is commonly adopted for hospitality assets, which provide both passive income from the rental of the assets and active income from the management and operation of the assets.

In such cases, the Reit will be constituted to hold the income-producing real estate assets and the business trust will be constituted to either:

(a) be the master lessee of the real estate assets who will manage and operate these assets, or

(b) remain dormant and only step in as a "master lessee of last resort" to manage and operate these assets when there are no other suitable master lessees to be found.

The presence of a business trust also offers flexibility for the stapled trust to undertake certain hospitality and hospitality-related development projects, acquisitions and investments that may not be suitable for the Reit.

In the case of EHT, EHBT was dormant.

Q: Could you explain EHT's master lease arrangement?

A: EHT adopted a master lease arrangement under which affiliates of its sponsor, Urban Commons, would lease hotels from EH-Reit. These affiliates, or master lessees, would in turn enter into:

(a) franchise agreements with various hotel franchisors to operate under their brands, and

(b) hotel management agreements with third-party hotel management companies to manage the day-to-day operations of each hotel.

Where a master lease arrangement is adopted, concentration risk is at its highest given the lack of diversity in lessees. The ability of the master lessees to keep up with timely rental payments becomes even more important. Rental income is ultimately the chief source of income for a Reit, property business trust or stapled trust.

As seen in the case of EHT, in certain cases, rental defaults could even result in the Reit, property business trust or stapled trust defaulting on its debt obligations and ultimately winding up.

Q: But EHT was marketed as having a diversified portfolio of real estate assets. Why was this diversification insufficient?

A: Indications that things were less than perfect surfaced shortly post-listing, in October 2019, when an article appeared in the press that EHT had been served with a notice of default by the City of Long Beach in respect of one of its properties, The Queen Mary.

These allegations were disputed by EHT, which claimed that the supposed notice of default was merely a "formal request for information by the City". Despite the assurances from EHT, however, the price of its stapled securities fell 14 per cent.

From late 2019 to early 2020, EHT's financial resources started to deplete due to the impact of Covid-19 as well as various delinquencies by the master lessees.

Some of the troubles encountered by the master lessees were:

(a) failing to pay rent on time,

(b) receiving notices of default from various hotel managers due to, among others, failure to provide and/or maintain sufficient working capital for the hotels' operations and failure to pay management fees, and

(c) receiving notices of termination from various hotel managers due to failure to cure the default of maintaining sufficient working capital for the hotels' operations.

During this period, EHT received a notice of default and acceleration in respect of a US$341 million loan it had taken out in connection with its listing.

In March 2020, EHT called for a voluntary suspension of trading.

Q: What went wrong? Why did so many missteps occur at the same time?

A: After EHT called for a voluntary suspension of trading, a special committee was established to safeguard value and conduct a strategic review. EHT subsequently appointed a financial adviser and implemented caretaker arrangements at the hotels that were the subject of the notice of termination by the relevant hotel managers.

In May 2020, the strategic review uncovered that the founders of Urban Commons (in their capacity as directors of various subsidiaries of EH-Reit) had, on behalf of these subsidiaries, entered into certain interested person transactions that were prejudicial to the interests of EHT and its minority stapled securityholders. This discovery prompted their resignations from the board of directors of the manager of EH-Reit and the trustee-manager of EHBT.

Later, the Monetary Authority of Singapore (MAS) and the Commercial Affairs Department of the Singapore Police Force commenced a joint investigation into current and former directors and officers responsible for the management of EHT in connection with suspected breach of disclosure requirements under the Securities and Futures Act.

Q: What will happen to EHT now?

A: EHT's financial adviser had initiated a request for proposal (RFP) process to find a new manager for EH-Reit.

In June 2020, this RFP process was interrupted by Urban Commons's entry into a letter of intent with Far East Consortium International. The latter was proposing to buy 70 per cent of EH-Reit's manager.

After discussions with Far East Consortium collapsed, the RFP process was restarted in late 2020. This culminated in the selection of SCCPRE Hospitality Reit Management as a potential replacement manager of EH-Reit. EHT securityholders were asked to vote on the appointment of SCCPRE as manager.

In or around the same period, EHT terminated the master lease agreements and the EH-Reit Trustee also received a directive from the MAS to remove the original manager of EH-Reit.

On Dec 30, 2020, EH-Reit's original manager was removed. But not all the requisite resolutions for the SCCPRE proposal were passed at the extraordinary general meeting held on the same day. In view of the absence of a replacement manager and inability to continue as a going concern because of the depletion of funds, EHT filed for insolvency protection under Chapter 11 of the United States Bankruptcy Code.

EHT has since disposed of 15 of its 18 hotel properties and also surrendered The Queen Mary back to the City of Long Beach. Stapled securityholders, however, are not expected to receive the sale proceeds as the cash is insufficient to repay all the other claims on EHT.

Q: Are such risks typically disclosed before a Reit's listing?

A: The prospectus is the primary offering document on which investors base their investment decisions. It should generally include all the information that investors and their professional advisers would reasonably require to make an informed assessment.

With respect to risk factors, the prospectus regulations generally require risks specific to the issuer to be disclosed. Risk factors that are typically included in the prospectus of a Reit, property business trust or stapled trust include those relating to the properties, such as certain properties being subject to restrictions, concentration risk, and risk that due diligence on the properties may not have uncovered all material defects.

The prospectus should also disclose risks relating to the issuer's operations, such as risk of failure in implementing investment strategy, the lack of an operating track record of the Reit manager or the trustee-manager, and risk of breach of obligations by the lessees.

Risks relating to investing in real estate, such as the relative illiquidity of real estate investments and risk that the rate of increase in rentals of the properties may be less than the inflation rate, are also typically included.

In addition, the prospectus may include risks relating to the jurisdictions in which the issuer operates, and risks relating to an investment in the units or stapled securities. This includes the risk that substantial unitholders or substantial stapled securityholders could sell a substantial number of units or stapled securities and risk of change in taxation laws.

Q: What kind of checks would have been conducted before EHT was allowed to list on the SGX?

A: Due diligence is conducted to evaluate an issuer's suitability for listing on the SGX. Under the listing manual of the SGX, the issue manager - who will manage the issuer's listing application - is tasked with the responsibility to "conduct adequate due diligence on the applicant".

Through the due diligence process, the issue manager, with the assistance of its advisers and other experts, identifies the necessary information for the preparation of a prospectus. Notably, the Securities and Futures Act imposes on certain persons criminal and civil liabilities for any false or misleading statement in or omission of material information from a prospectus.

The issue manager is guided by the due diligence guidelines issued by The Association of Banks (ABS) in Singapore, which SGX will have regard to when assessing the adequacy of due diligence conducted.

Among others, the ABS Listings Due Diligence Guidelines recommend an issue manager review the educational and professional qualifications, experience and expertise of the proposed directors and executive officers of the issuer to assess their suitability.

The issue manager should also achieve a thorough understanding of the issuer and its business through reasonable due diligence; and with the assistance of advisers, carry out reasonable checks and make enquiries as are reasonable in the circumstances to satisfy itself that the information contained in the prospectus - subject to reasonable reliance on experts - is compliant with law.

Where there is reliance on the reports and opinions of experts, the issue manager should take measures to satisfy itself that such reliance is reasonable in the circumstances and there are no reasonable grounds to believe that the information in such reports and opinions is untrue or misleading in any material respect or contains any material omission.

In the context of a Reit, property business trust or stapled trust listing, due diligence on the initial portfolio of properties is of utmost importance.

In this regard, due diligence will generally involve on-site visits to the properties and the engagement of independent property valuers to conduct a valuation of the properties as well as provide a thorough analysis of the properties.

Legal advisers should also be engaged to conduct legal due diligence to confirm that good title to the properties will be obtained; identify key approvals; confirm that material contracts such as leases are legal, binding and enforceable; and identify ongoing and past litigations and investigations.

As part of this legal due diligence, the legal advisers will also:

• identify scope of insurance coverage;
• identify caveats, security interests, easements, covenants and licences;
• assess compliance with zoning and planning permissions; and
• obtain information on road line plans, survey plans and property boundaries.

In addition, technical consultants should be engaged to assess the structural integrity of the properties and identify material defects; while environmental consultants are engaged to assess the environmental conditions of the properties in order to identify actual and potential environmental liabilities.

Financial due diligence should be conducted with the assistance of reporting accountants to analyse the financial health of the issuer and to prepare the pro forma financial information as well as the profit forecast and profit projection sections, which are to be included in the prospectus.

Taxation experts should also be engaged to identify and assess the taxation issues in connection with a listing. To the extent necessary, favourable tax rulings may need to be obtained from the relevant authorities.

Q: But is there any way investors could have known something was wrong in the first place? Can anything be done to prevent a repeat of this?

A: The case of EHT has resulted in the public calling for the authorities to review the current disclosure regime. In particular, it has been questioned if the rules should also require disclosure of the financials of a sponsor - especially if a master lease arrangement with the sponsor is adopted.

Where a master lease arrangement is adopted, valuations of the properties and financials presented in the prospectus would be based on the rental income received under such master lease arrangement. For these figures to remain accurate, the master lessees need to be able to fulfil their end of the bargain. Requiring such disclosures would allow investors to better assess a sponsor's financial strength.

Short of any amendment to the disclosure regime, issuers will do well to treat the required disclosures as the minimum standard and aim to go above and beyond in the interests of investors.

This article is brought to you by Robson Lee, a partner of Gibson Dunn