13. Commitments and Contingencies

Management Agreements

Management agreements with the Company’s third-party hotel managers require the Company to pay between 2% and 3.5% of total revenue of the managed hotels to the third-party managers each month as a basic management fee. Total basic management fees incurred by the Company during the years ended December 31, 2014, 2013 and 2012 were included in the Company’s consolidated statements of operations as follows (in thousands):


	2014		2013		2012
Continuing operations — property general and administrative expense, and corporate overhead expense	$	31,485	$	25,218	$	22,807
Discontinued operations		—		65		2,061
	$	31,485	$	25,283	$	24,868

In addition to basic management fees, provided that certain operating thresholds are met, the Company may also be required to pay incentive management fees to certain of its third-party managers. Total incentive management fees incurred by the Company during the years ended December 31, 2014, 2013 and 2012 were included in the Company’s consolidated statements of operations as follows (in thousands):


	2014		2013		2012
Continuing operations — property general and administrative expense	$	4,034	$	3,025	$	2,738
Discontinued operations		—		—		587
	$	4,034	$	3,025	$	3,325

License and Franchise Agreements

The Company has entered into license and franchise agreements related to certain of its hotel properties. The license and franchise agreements require the Company to, among other things, pay monthly fees that are calculated based on specified percentages of certain revenues. The license and franchise agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of the hotels which are established by the franchisors to maintain uniformity in the system created by each such franchisor. Such standards generally regulate the appearance of the hotel, quality and type of goods and services offered, signage and protection of trademarks. Compliance with such standards may from time to time require the Company to make significant expenditures for capital improvements.

Total license and franchise fees incurred by the Company during the years ended December 31, 2014, 2013 and 2012 were included in the Company’s consolidated statements of operations as follows (in thousands):


	2014		2013		2012
Continuing operations — franchise costs	$	38,271	$	32,932	$	30,067
Discontinued operations		—		73		2,996
	$	38,271	$	33,005	$	33,063

Total license and franchise costs included royalties of $11.6 million, $10.8 million and $10.6 million incurred by the Company during the years ended December 31, 2014, 2013 and 2012, respectively. The remaining costs included advertising, reservation and priority club assessments.

Renovation and Construction Commitments

At December 31, 2014, the Company had various contracts outstanding with third parties in connection with the renovation of certain of its hotel properties aimed at maintaining the appearance and quality of its hotels. The remaining commitments under these contracts at December 31, 2014 totaled $56.5 million.

Capital Leases

The Hyatt Chicago Magnificent Mile is subject to a building lease which expires in December 2097. Upon acquisition of the hotel in June 2012, the Company evaluated the terms of the lease agreement and determined the lease to be a capital lease pursuant to the Leases Topic of the FASB ASC.

The Company leases certain printers and copiers which leases have been determined to be capital leases pursuant to the Leases Topic of the FASB ASC. All of the leases expired in December 2014.

Assets under capital lease were included in investment in hotel properties, net on the Company’s consolidated balance sheets as follows (in thousands):


	December 31,
	2014		2013
Buildings and improvements	$	58,799	$	58,799
Furniture, fixtures and equipment		104		104
		58,903		58,903
Accumulated depreciation		(3,841)		(2,356)
	$	55,062	$	56,547

Future minimum lease payments under capital leases together with the present value of the net minimum lease payments as of December 31, 2014 are as follows (in thousands):


2015	$	1,409
2016		1,403
2017		1,403
2018		1,403
2019		1,403
Thereafter		109,414
Total minimum lease payments (1)		116,435
Less: Amount representing interest (2)		(100,852)
Present value of net minimum lease payments (3)	$	15,583

(1)

Minimum lease payments do not include percentage rent which may be paid under the Hyatt Chicago Magnificent Mile building lease on the basis of 4.0% of the hotel’s gross room revenues over a certain threshold. The Company recorded zero in percentage rent during both 2014 and 2013, and $3,000 in percentage rent during 2012.

(2)

Interest includes the amount necessary to reduce net minimum lease payments to present value calculated at the Company’s incremental borrowing rate at lease inception.

(3)

The present value of net minimum lease payments are reflected in the Company’s consolidated balance sheet as of December 31, 2014 as a current obligation of $7,000, which is included in accounts payable and accrued expenses, and as a long-term obligation of $15.6 million, which is included in capital lease obligations, less current portion.

Ground, Building and Air Leases

During 2014, 2013 and 2012, certain of the Company’s 30 hotels were obligated to unaffiliated third parties under the terms of ground, building and air leases as follows:


	2014	2013	2012
Number of hotels with ground, building and/or air leases	9	10	10

Number of ground leases	8	9	9
Number of building leases (1)	1	1	1
Number of air leases	3	3	3
Total number of ground, building and air leases	12	13	13

(1)

The building lease is considered by the Company to be a capital lease, as noted above.

At December 31, 2014, the ground, building and air leases mature in dates ranging from 2037 through 2097, excluding renewal options. One of the air leases requires a payment of $1.00 annually, which the Company has paid in full for the life of the lease. Total rent expense incurred pursuant to ground, building and air lease agreements for the years ended December 31, 2014, 2013 and 2012 was included in property tax, ground lease and insurance in the Company’s consolidated statements of operations as follows (in thousands):


	2014		2013		2012
Minimum rent, including straightline adjustments	$	14,999	$	15,228	$	14,950
Percentage rent (1)		2,718		2,131		2,000
	$	17,717	$	17,359	$	16,950

(1)

Several of the Company’s hotels pay percentage rent, which is calculated on operating revenues above certain thresholds.

Prior to the Company’s June 2014 acquisition of the land underlying the Fairmont Newport Beach, the land was leased to the Company by a third party. The Company’s acquisition of the land reduced its ground lease expense by $0.6 million during 2014.

At December 31, 2014, the Company was obligated to an unaffiliated party under the terms of a sublease on the corporate facility, which matures in 2018. Rent expense incurred pursuant to leases on the corporate facility totaled $0.4 million for each of the years ended December 31, 2014, 2013 and 2012, and was included in corporate overhead expense.

Future minimum payments under the terms of the ground and air leases, as well as the sublease on the corporate facility, in effect at December 31, 2014 are as follows (in thousands):


2015	$	8,438
2016		8,499
2017		11,523
2018		11,450
2019		11,236
Thereafter		335,009
Total	$	386,155

Employment Agreements

As of December 31, 2014, the Company has employment agreements with certain executive employees, which expire in August 2016. The terms of the agreements stipulate payments of base salaries and bonuses.

Approximate minimum future obligations under employment agreements are as follows as of December 31, 2014 (in thousands):


2015	$	6,319
2016		706
	$	7,025

Collective Bargaining Agreements

The Company is subject to exposure to collective bargaining agreements at certain hotels operated by its management companies. At December 31, 2014, approximately 29.2% of workers employed by the Company’s third-party managers were covered by such collective bargaining agreements.

401(k) Savings and Retirement Plan

The Company’s employees may participate, subject to eligibility, in the Company’s 401(k) Savings and Retirement Plan (the “401(k) Plan”). Employees are eligible to participate in the 401(k) Plan after attaining 21 years of age and after the first of the month following the performance of six months of service. Three percent of eligible employee annual base earnings are contributed by the Company as a Safe Harbor elective contribution. Safe Harbor contributions made by the Company totaled $0.3 million for the year ended December 31, 2014, and $0.2 million for both of the years ended December 31, 2013 and 2012, and were included in corporate overhead expense.

The Company is also responsible for funding various retirement plans at certain hotels operated by its management companies. Property general and administrative expense on the Company’s consolidated statements of operations includes matching contributions into these various retirement plans of $1.5 million, $1.1 million and $0.9 million for the years ended December 31, 2014, 2013 and 2012, respectively. Discontinued operations on the Company’s consolidated statements of operations includes matching contributions into these retirement plans of zero for the year ended December 31, 2014, $3,000 for the year ended December 31, 2013, and $0.1 million for the year ended December 31, 2012.

Concentration of Risk

The concentration of the Company’s hotels in California, New York, Illinois, Massachusetts and the greater Washington DC area exposes the Company’s business to economic conditions, competition and real and personal property tax rates unique to these locales. As of December 31, 2014, the Company’s 30 hotels were concentrated in California, New York, Illinois, Massachusetts and the greater Washington DC area as follows:


									Greater
									Washington DC
	California		New York		Illinois		Massachusetts		Area
Number of hotels	9		3		3		3		3
Percentage of total rooms	31	%	9	%	8	%	14	%	13	%
Percentage of total revenue for the year ended December 31, 2014	33	%	13	%	7	%	14	%	12	%

Other

The Company has provided customary unsecured environmental indemnities to certain lenders. The Company has performed due diligence on the potential environmental risks, including obtaining an independent environmental review from outside environmental consultants. These indemnities obligate the Company to reimburse the indemnified parties for damages related to certain environmental matters. There is no term or damage limitation on these indemnities; however, if an environmental matter arises, the Company could have recourse against other previous owners or a claim against its environmental insurance policies.

At December 31, 2014, the Company had $0.7 million of outstanding irrevocable letters of credit to guaranty the Company’s financial obligations related to workers’ compensation insurance programs from prior policy years. The beneficiaries of these letters of credit may draw upon these letters of credit in the event of a contractual default by the Company relating to each respective obligation. No draws have been made through December 31, 2014.