Commitments and Contingencies

6 Months Ended

Jun. 30, 2020

Commitments and Contingencies Disclosure [Abstract]

Hotel Management and Franchise Agreements

Management Fees

On May 30, 2018, wholly owned subsidiaries of the Company entered into separate hotel management agreements for each of our hotels with LQ Management L.L.C. (“LQM”), whereby we pay a fee equal to 5% of total gross revenues, as defined. The term of the management agreements is 20 years subject to two renewals of five years each, at LQM’s option. There are penalties for early termination.

LQM generally has sole responsibility for all activities necessary for the operation of the hotels, including establishing room rates, processing reservations and promoting and publicizing the hotels. LQM also provides all employees for the hotels, prepares reports, budgets and projections, and provides other administrative and accounting support services to the hotels. We have consultative and limited approval rights with respect to certain actions of LQM, including entering into long-term or high value contracts, engaging in certain actions relating to legal proceedings, approving the operating budget, making certain capital expenditures and the hiring of certain management personnel. We are also responsible for reimbursing LQM for certain costs incurred by LQM during the fulfillment of their duties, such as payroll costs for certain employees, general liability insurance and other costs that the manager incurs to operate the hotels.

For the three months ended June 30, 2020 and 2019, our management fee expense was $3 million and $10 million, respectively. For the six months ended June 30, 2020 and 2019, our management fee expense was $10 million and $21 million, respectively.

Royalty Fees

On May 30, 2018, we entered into separate hotel franchise agreements for each of our hotels with La Quinta Franchising LLC (“LQ Franchising”). Pursuant to the franchise agreements, we were granted a limited, non-exclusive license to use our franchisor’s brand names, marks and system in the operation of our hotels. The franchisor also may provide us with a variety of services and benefits, including centralized reservation systems, participation in customer loyalty programs, national advertising, marketing programs and publicity designed to increase brand awareness, as well as training of personnel. In return, we are required to operate franchised hotels consistent with the applicable brand standards.

Our franchise agreements require that we pay a 5% royalty fee on gross room revenue. The term of the franchise agreements is through 2038, subject to one renewal of ten years, at our option, subject to certain conditions. There are penalties for early termination. For the three months ended June 30, 2020 and 2019, our royalty fee expense was $4 million and $11 million, respectively. For the six months ended June 30, 2020 and 2019, our royalty fee expense was $11 million and $21 million, respectively. LQ Franchising has deferred the payment of the royalty and certain other franchise fees for March through May 2020 (interest-free) until September 1, 2020, due to the impact of the COVID-19 pandemic.

In addition to the royalty fee, the franchise agreements include a reservation fee of 2% of gross room revenues, a marketing fee of 2.5% of gross room revenues, a loyalty program fee of 5% of eligible room night revenues, and other miscellaneous ancillary fees. Reservation fees are included within rooms expense and the marketing fee and loyalty program fees are included within other departmental and support in the accompanying consolidated statements of operations.

Our requirement to meet certain brand standards imposed by our franchisor includes requirements that we incur certain capital expenditures, generally ranging from $1,500 to $7,500 per hotel room (with various specific amounts within this range being applicable to different groups of our hotels) during a prescribed period generally ranging from two to eleven years. These amounts are over and above the capital expenditures we are required to make each year for recurring furniture, fixtures and equipment maintenance. However, these amounts that we are required to spend are subject to reduction, in varying degrees, by the amount of capital expenditures made for hotels in the applicable group over and above the capital expenditures required for the recurring maintenance in one or more years before receipt of the franchisor’s notice. The initial period during which the franchisor can notify us that we must make these capital expenditures is through 2028. At the franchisor’s discretion, subject to the franchise agreement provisions governing when such requirements may be imposed, the franchisor may provide a notice obligating us to meet those capital expenditure requirements generally within two to nine years of the notice. We expect to meet these requirements primarily through our recurring capital expenditure program. As of June 30, 2020, $15 million was held in lender escrows that can be used to fund these requirements. As a result of the impact of the COVID-19 pandemic, our franchisor has waived any brand standards that requires capital investment (except for health and safety standards) until January 1, 2021.

Litigation

We are a party to a number of pending claims and lawsuits arising in the normal course of business. We do not consider our ultimate liability with respect to any such claims or lawsuits, or the aggregate of such claims and lawsuits, to be material in relation to our condensed consolidated financial condition, results of operations or our cash flows taken as a whole.

We maintain general and other liability insurance; however, certain costs of defending lawsuits, such as those within the retention or insurance deductible amount, are not covered by or are only partially covered by insurance policies. We regularly evaluate our ultimate liability costs with respect to such claims and lawsuits. We accrue costs from litigation as they become probable and estimable.

Tax Contingencies

We are subject to regular audits by federal and state tax authorities, which may result in additional tax liabilities. In 2018, La Quinta Holdings Inc. completed the distribution to its stockholders of all the then-outstanding shares of common stock of CorePoint Lodging Inc. following which we became an independent, self-administered, publicly traded company (the “Spin-Off”). Subsequently, La Quinta Holdings Inc. merged with Wyndham Hotels & Resorts, Inc. (“Wyndham”). Entities in existence prior to the Spin-Off are currently under audit by the IRS for tax years ended December 31, 2010 to 2013. We have agreed to indemnify Wyndham for any obligations and expenses arising from these IRS audits, including the legal and accounting defense expenses.

In 2014, the IRS commenced a tax audit, primarily related to transfer pricing for internal rents charged by our prior REIT. Subsequently, we have supplied information to the IRS supporting our position. In November 2019, the IRS issued notices of proposed adjustments (“NOPA”, also known as a 30 Day Letter) proposing a redetermined rent adjustment resulting in approximately $138 million of additional federal taxes, attributable to tax years 2010 and 2011, exclusive of penalties and interest. Additionally, the November 2019 NOPA proposed an adjustment resulting in the loss of tax operating loss carryforwards generated in tax years 2006 through 2009. The adjustment to the tax operating loss carryforwards, measured at the tax rates enacted during the year of utilization and exclusive of penalties and interest, is $31 million.

We responded to the IRS in disagreement with its NOPA in January 2020. In April 2020, the IRS responded in disagreement to our response. Due to the COVID-19 pandemic and IRS offices being temporarily closed, the transfer of the audit to IRS Appeals office has been delayed, and no date has been established for when it will be transferred to the IRS Appeals office and the appeals process will commence.

We believe the IRS transfer pricing methodologies applied in the audits contain flaws and that the IRS proposed tax and adjustments are inconsistent with the U.S. federal tax laws. We have concluded that the positions reported on our tax returns under audit by the IRS are, based on their technical merits, more-likely-than-not to be sustained upon conclusion of the examination. Accordingly, as of June 30, 2020, we have not established any reserves related to this proposed adjustment or any other issues reflected on the returns under examination. If, however, we are unsuccessful in challenging the IRS, an excise tax would be imposed on the REIT related to the excess rent and we would be responsible for additional income taxes, interest and penalties, which could adversely affect our financial condition, results of operations and cash flow and the trading price of our common stock. Such adjustments could also give rise to additional state income taxes.

Purchase Commitments

As of June 30, 2020, we had approximately $23 million of purchase commitments related to certain continuing redevelopment and renovation projects and other hotel service contracts in the ordinary course of business. Approximately $18 million of this amount relates to long-term hotel service contracts payable over approximately four years.

Lease Commitments

As a lessee, our arrangements are primarily ground leases for certain of our hotels. These ground leases generally include base rents, which may be reset based on inflation indexes or pre-established increases, contingent rents based upon the respective hotel’s revenues, and reimbursement or primary responsibility for related real estate taxes and insurance expenses. The initial base terms for the leases are generally in excess of 25 years, with initial term maturities occurring between 2022 and 2096. Many of these arrangements also contain renewal options at the conclusion of the initial lease term, generally at fair value or pre-set amounts. Our other operating leases primarily relate to our corporate office.

The contractual maturity analysis of all of our operating lease liabilities on an undiscounted basis as of June 30, 2020 is as follows (in millions):


Year	Amount
2020 (remaining six months)	$	2
2021	3
2022	3
2023	3
2024	3
2025	2
Thereafter	58
	$	74

The difference between the undiscounted contractual payments of $74 million above and the June 30, 2020 operating lease liabilities of $24 million (included in our “other liabilities”) is the present value of imputed interest. Contractual payments include base rents that have been contractually reset based on inflation indexes as of June 30, 2020.

We had no rent expense for the three months ended June 30, 2020 and $1 million of rent expense for the three months ended June 30, 2019. For the six months ended June 30, 2020, total rent expense was $1 million, as compared to $2 million for the six months ended June 30, 2019. Differences between amounts expensed and cash paid were not significant. Rent expense is included in property tax, insurance and other expenses in our condensed consolidated statement of operations.

Post-employment Benefits

We have entered into severance plans with all executives and other employees. New employees are added at their date of employment. The plans include salary continuation, severance benefits, continuation of health care coverage and other supplemental post-employment benefits, all which vary depending on the employee’s position and apply where there is termination without cause. We had no expenses related to these severance plans in the three or six months ended June 30, 2020. During the three and six months ended June 30, 2019, we incurred $6 million of corporate general and administrative expense related to these severance plans.