12. Commitments and Contingencies

Management Agreements

Management agreements with the Company’s third-party hotel managers require the Company to pay between 2.0% and 3.5% of total revenue of the managed hotels to the third-party managers each month as a basic management fee. 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 basic management fees, net of key money incentives received from third-party hotel managers, along with incentive management fees incurred by the Company during the years ended December 31, 2016, 2015 and 2014 were included in the Company’s consolidated statements of operations as follows (in thousands):


	2016		2015		2014
Basic management fees	$	33,109	$	34,426	$	31,485
Incentive management fees		6,071		5,020		4,034
Total basic and incentive management fees	$	39,180	$	39,446	$	35,519

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, 2016, 2015 and 2014 were included in the Company’s consolidated statements of operations as follows (in thousands):


	2016		2015		2014
Franchise assessments (1)	$	26,399	$	28,193	$	26,689
Franchise royalties		10,248		11,903		11,582
Total franchise costs	$	36,647	$	40,096	$	38,271

(1)

Includes advertising, reservation and frequent guest club assessments.

Renovation and Construction Commitments

At December 31, 2016, the Company had various contracts outstanding with third parties in connection with the renovation and repositioning of certain of its hotel properties. The remaining commitments under these contracts at December 31, 2016 totaled $38.0 million.

Capital Leases

The Hyatt Centric 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 capital lease asset was included in investment in hotel properties, net on the Company’s consolidated balance sheets as follows (in thousands):


	December 31,
	2016		2015
Gross capital lease asset - buildings and improvements	$	58,799	$	58,799
Accumulated depreciation		(6,738)		(5,268)
Net capital lease asset - buildings and improvements	$	52,061	$	53,531

Future minimum lease payments under for the Company’s capital lease together with the present value of the net minimum lease payments as of December 31, 2016 are as follows (in thousands):


2017	$	1,403
2018		1,403
2019		1,403
2020		1,403
2021		1,403
Thereafter		106,607
Total minimum lease payments (1)		113,622
Less: Amount representing interest (2)		(98,047)
Present value of net minimum lease payments (3)	$	15,575

(1)

Minimum lease payments do not include percentage rent, which may be paid under the Hyatt Centric 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 $0.1 million in percentage rent during both 2016 and 2015, and zero in percentage rent during 2014.

(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, 2016 as a current obligation of $1,000, 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 2016, 2015 and 2014, certain of the Company’s hotels were obligated to unaffiliated third parties under the terms of ground, building and air leases as follows:


	2016	2015	2014
Number of hotels with ground, building and/or air leases (1)	6	8	9

Number of ground leases (1)	6	7	8
Number of building leases (2)	1	1	1
Number of air leases (1)	1	2	3
Total number of ground, building and air leases	8	10	12

(1)

Both 2015 and 2014 include a ground lease related to the Sheraton Cerritos, which the Company sold in May 2016, as well as an air rights lease at the Renaissance Harborplace, which air rights the Company purchased in June 2016. 2014 includes ground and air leases related to the Doubletree Guest Suites Times Square, which the Company sold in December 2015.

(2)

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

At December 31, 2016, the ground, building and air lease agreements mature in dates ranging from 2044 through 2097, excluding renewal options. Total rent expense incurred pursuant to ground, building and air lease agreements for the years ended December 31, 2016, 2015 and 2014 was included in property tax, ground lease and insurance in the Company’s consolidated statements of operations as follows (in thousands):


	2016		2015		2014
Minimum rent, including straight-line adjustments	$	9,140	$	14,484	$	14,999
Percentage rent (1)		9,394		3,256		2,718
Total	$	18,534	$	17,740	$	17,717

(1)

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

At December 31, 2016, 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, which is included in corporate overhead expense, totaled $0.2 million, $0.3 million and $0.4 million for the years ended December 31, 2016, 2015 and 2014, respectively.

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, 2016 are as follows (in thousands):


2017	$	10,184
2018		10,143
2019		10,012
2020		10,029
2021		10,030
Thereafter		309,647
Total	$	360,045

Employment Agreements

As of December 31, 2016, the Company had employment agreements with certain executive employees, which expire in either March 2017 or March 2018. The terms of the agreements stipulate payments of base salaries and bonuses. The Company’s approximate minimum future obligations under employment agreements through their expiration dates totaled $1.3 million as of December 31, 2016.

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”). Qualified 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 completion of six calendar months of employment. 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 $0.2 million for both of the years ended December 31, 2016 and 2015, and $0.3 million for the year ended December 31, 2014, and were included in corporate overhead expense for the Company’s corporate employees and other property-level expenses for the Company’s former BuyEfficient employees.

The Company is also responsible for funding various retirement plans at certain hotels operated by its management companies. Other property-level expenses on the Company’s consolidated statements of operations includes matching contributions into these various retirement plans of $1.6 million for the year ended December 31, 2016, and $1.5 million for both of the years ended December 31, 2015 and 2014.

Collective Bargaining Agreements

The Company is subject to exposure to collective bargaining agreements at certain hotels operated by its management companies. At December 31, 2016, approximately 23.4% of workers employed by the Company’s third-party managers were covered by such collective bargaining agreements.

Concentration of Risk

The concentration of the Company’s hotels in California, 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, 2016, 16 of the Company’s 27 hotels were concentrated in California, Illinois, Massachusetts and the greater Washington DC area as follows:


							Greater
							Washington DC
	California		Illinois		Massachusetts		Area
Number of hotels	7		3		3		3
Percentage of total rooms	29	%	9	%	15	%	14	%
Percentage of total revenue for the year ended December 31, 2016	34	%	7	%	15	%	13	%

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, 2016, the Company had $0.5 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, 2016.

The Company is subject to various claims, lawsuits and legal proceedings, including routine litigation arising in the ordinary course of business, regarding the operation of its hotels and Company matters. While it is not possible to ascertain the ultimate outcome of such matters, the Company believes that the aggregate amount of such liabilities, if any, in excess of amounts covered by insurance will not have a material adverse impact on its financial condition or results of operations. The outcome of claims, lawsuits and legal proceedings brought against the Company, however, is subject to significant uncertainties.