By Matthew Santoni

Law360 (June 22, 2021, 8:55 PM EDT) -- The Ace Hotel in Pittsburgh failed to manage its budget throughout most of its existence, but the building owners were trying to sell it out from under Ace even before their effort to oust the boutique brand became official, according to testimony Tuesday in Pennsylvania state court.

Nate Cunningham, a developer and principal of building owner Y Hotel LP and landlord Y Hotel Master Tenant LLC, told the Allegheny County Court of Common Pleas that the hip hotelier managing the rooms and restaurant had failed to control its budget ever since the hotel's opening in late 2015, meaning that Y Hotel was struggling to make payments on the various loans that supported the $23 million renovation of a historic YMCA in the up-and-coming East Liberty neighborhood.

"Everybody was very familiar with Ace's failures as manager," Cunningham said. "The financial documents speak for themselves … the lenders lost confidence in Ace's ability to manage this property."

Common Pleas Judge Christine Ward heard about six hours of testimony Tuesday as part of Ace's bid for a preliminary injunction barring it from being removed as the manager and brand behind the hotel, which has been closed since the coronavirus began sweeping through the U.S. in March 2020.

Despite Y Hotel's arguing to the court in May that there had been no foreclosure or sale to trigger Ace's rights under its contracts, Cunningham testified Tuesday that there were a few potential buyers who had started the sale process, and they were doing due diligence with the assurance that the current owners intended to boot Ace from the building. But the buyers ultimately backed out because of the litigation from Ace over the management, he said.

Alex Hershey of Clark Hill PLC, representing the owners, said that the proposed sales still didn't trigger the agreements, and that even though the hotel had fallen behind on its loan payments, none of the lenders had foreclosed or otherwise tried to take over the property.

Ace had underperformed its budget by hundreds of thousands of dollars for three of the four years between its opening and when the pandemic shut it down, Cunningham said, and it had failed to lower its expenses when its revenues weren't keeping pace.

Ace had countered that the building itself was encumbered by millions in debt from the start. Cunningham spoke of a complex mix of equity, loans and tax credits for investing in a low-income neighborhood and in historic property that passed through "community development entities," or CDEs, to finance the building's redevelopment. Y Hotel LP was responsible for paying the loans, while Y Hotel Master Tenant would collect revenue from Ace's management of the hotel and pay that to Y Hotel LP as about $1 million per year in rent.

Most of the time, he said, Ace wasn't making enough in net operating income to pay that rent, so the loans fell behind as well. Sometimes Ace wouldn't even have enough to cover its payroll, and the contracts obligated him to cover the shortfall. Ace President Brad Wilson said Ace agreed to postpone taking about $800,000 in fees so Y Hotel could pay its bills, while Cunningham said they also agreed to leave the rent off the yearly budget so employees wouldn't be demoralized by the red ink.

Cunningham said he started the process of declaring Ace in default of the management agreement and terminating that agreement in April and May 2020, getting approval from the lenders that had allegedly "lost faith" in the operator. Around the same time, Ace demanded payment for the deferred fees.

When the pandemic hit, Ace recommended closing, so the hotel shut down, took a Paycheck Protection Program loan to try to keep paying people, and gradually let go of nearly 100 workers until the last two quit in August. The departing general manager and controller padlocked the doors and set their emails to forward messages from unpaid vendors and upset wedding planners to Cunningham's address, he said.

But Doug Hance of Morris Manning & Martin LLP, representing Ace, said the company's contracts gave it an equity interest in the property through another of the Y Hotel entities, and through the work it put into designing and branding the building. Other parts of its agreements with the owner said the hotel could not be sold without Ace's approval or transferred in a foreclosure without keeping Ace on as the manager.

"The owner stopped funding the hotel, and six months later tried to sell without Ace's approval," Hance said. "The owner tried to terminate Ace's management agreement for manufactured reasons, so the hotel would be unencumbered for its sale."

Cunningham said the owners proposed opening some rooms and booking them through Airbnb to restart an income stream around Memorial Day, but the court squashed that plan amid Ace's arguments that it would be harmed by losing its brand at the building.

Ace disputed that the hotel management agreement had been properly terminated. A separate dispute over that agreement went to arbitration but was withdrawn after the building owners were unable to pay the cost of arbitration upfront, and Ace didn't want to foot the whole bill.

Wilson, the only other witness to testify Tuesday, said the management had not breached its agreement and the hotel had still outperformed other, comparable area hotels once the contract's grace period expired in 2019 and its performance requirements kicked in.

Cunningham said other factors went into the termination, including the failure of the performance standards, unclear accounting of Ace's fees, and a dispute over control of a bank account that was controlled by Ace but viewable by Y Hotel Master Tenant, the hotel ownership group. From it, Ace's corporate parent would withdraw its fees and pay Y Hotel its rent, if there was enough in it.

After accepting two affidavits from representatives of the lenders in lieu of further testimony, Judge Ward asked for closing briefs from the parties and said she would rule on the injunction shortly after she receives them all.

Ace Group Pittsburgh LLC is represented by Gretchen E. Moore and Christopher J. Azzara of Strassburger McKenna Gutnick & Gefsky, and Robert Alpert and Douglas M. Hance of Morris Manning & Martin LLP.

Y Hotel LP and Y Master Tenant LLC are represented by J. Alexander Hershey, Danny P. Cerrone Jr. and Samuel A. Hornak of Clark Hill PLC.

The lenders are represented by Andrew J. Muha of Reed Smith LLP.

The case is Ace Group Pittsburgh v. Y Hotel LP et al., case number GD-21-001310, in the Court of Common Pleas of Allegheny County, Pennsylvania.

--Editing by Ellen Johnson.

For a reprint of this article, please contact reprints@law360.com.