The Big Four U.S.-headquartered online travel companies -- Expedia Inc., Priceline.com, Orbitz Worldwide and Travelocity -- were socked with a $20.6 million hotel occupancy tax tab as a federal jury in San Antonio, Texas, ruled against them in a class-action civil lawsuit brought on behalf of 173 of the state's cities and towns.
The City of Houston, the fourth largest city in the U.S. and the most-populous in Texas, was not a party to the suit and is pursuing its own legal action against the OTCs.
The U.S. district court jury in City of San Antonio v. Hotels.com found that the OTCs were "controlling hotels" when they sold room nights on a merchant-model basis, and thus were liable for tax on their retail rates and not just the wholesale deals they got from the hotels.
The cities' ordinances do not define what "controlling" means, and the judge instructed the jury "to use your common sense" about the intended meaning of "controlling hotels."
The OTCs did not prevail in their contention that since they are not hotel operators and take no inventory risk, therefore they do not control hotels under Texas law and should not be subject to occupancy taxes on the retail rate.
Anyone who doubts the stakes for Choice Hotels in its contract dispute with Expedia Inc. or wonders about Expedia's distribution clout, need merely look at the San Antonio jury's tallies in the hotel tax dispute.
In the $20.6 million decision, the jury tagged Expedia Inc. companies (Expedia.com, hotels.com and Hotwire) for some $15.1 million.
Here are the other, much smaller, liabilities:
Priceline.com Inc. (including Priceline.com and Travelweb): $2.03 million.
Orbitz Worldwide (including Orbitz.com, Lodging.com and CheapTickets.com): $1.95 million.
And, Travelocity.com L.P. (including Travelocity.com and Site59.com): $1.5 million.
One factor in Expedia.com's oversized liability compared with Priceline, Orbitz and Travelocity is that the jury assessed Expedia Inc.'s hotels.com unit, which may have had at least a five-year headstart over its peers in merchant-model hotel sales, with a $7.3 million liability, outpacing even Expedia.com at $6.2 million.
But even if you disregard hotels.com's pioneering efforts in the merchant model business, Expedia Inc. today is the undisputed power in online hotel distribution.
I wrote the other day how Expedia generated 64% of its revenue from its hotels business in the third quarter. It's precisely because of all the pressures on the OTCs' merchant model business, including these tax fights, that make it so hard to predict where the merchant model business is heading.
Consider the distractions.
In a recent Securities and Exchange Commission document, filed before the San Antonio ruling, Expedia Inc. noted that it established reserves of $20 million and $21 million on Dec. 31, 2008, and Sept. 30, 2009, respectively, to cover potential municipal settlements in the hotel tax cases, of which 59 were filed by cities and counties over the last five years. Five of these cases have been dismissed on the merits.
But Expedia was on the losing side in tiny Columbus, Ga., and is appealing an adverse $17.7 million ruling in Anaheim, Calif.
To appeal another detrimental ruling in a City of San Francisco case, Expedia Inc. paid $35 millon to the city in July 2009, and wracked up another $20 million bill for the quarter which ended June 30, 2009. Expedia stated it expects to pay that $20 million to San Francisco before the end of the year.
Then, while the above lawsuits involve cities and counties, Expedia was hit with a $185 million adverse ruling in a breach of contract claim filed by consumers in Washington state. Expedia reached a tentative settlement in that case and estimates settlement costs could range from $19 million to $134 million, and set aside, as of the end of September, the lower amount, $19 million, toward the settlement.
With stakes as large as these, the OTCs are very sensitive about the tax issue, and the threat to the sweet spot of their businesses.
In fact, their trade association, ITSA, contacted me -- and I appreciate that it did -- about the San Antonio decision before I was even aware that the ruling came down Oct. 30.
ITSA spokesman Andrew Weinstein says the OTCs view the San Antonio jury's decisions "as a glass-half full kind of thing."
That's because although the jury found that the OTCs "control hotels" and are subject to the additional taxes, the jury did not find fault with the OTCs on the "conversion" issue, which is a perennial allegation in the across-the-country litigations. That is, the jury did not concur with the cities' allegations that the OTCs actually collected occupancy taxes on the retail rate and then just converted the monies into nest eggs without remitting the taxes to cities and towns.
"We believe this puts the conversion myth to bed once and for all, and it will make it much harder for the plaintiffs' attorneys to misinform and deceive other municipalities on that point," Weinstein says.
He also points out that the jury in San Antonio declined to tack on compensatory and punitive damages.
On the core question of whether the OTCs control hotels and are liable for occupancy taxes in these Texas municipalities, Weinstein says the OTCs are confident that they would prevail upon appeal, a course of action they intend to pursue.
Travelocity, headquartered in Southlake, Texas, came out swinging after the San Antonio verdict.
Here's Travelocity's statement.
"We are gratified that the jury in San Antonio found in our favor that, despite the repeated false claims of the contingency fee lawyers driving this and other cases, Travelocity has never collected taxes that it has not remitted to a proper taxing authority. Travelocity takes its tax obligations very seriously."
Travelocity continues: "We plan to appeal the part of the San Antonio decision that inexplicably and wrongly found that online travel companies 'control hotels,' suggesting we literally have some control over the physical hotel buildings. The contingency fee lawyers convinced the jury to apply San Antonio’s ordinance in a novel way that is inconsistent with what is clearly written in the ordinance and its original intent. Hotel owners themselves and the only expert witness in the case testified that online travel companies do not control hotels. Another federal court in Texas reviewing a nearly identical ordinance concluded that online travel companies are not subject to hotel occupancy taxes. This part of the verdict is clearly wrong and we do not believe it can survive on appeal."
Obviously, the San Antonio jury disagreed with ITSA and Travelocity about the control issue -- and rulings of the 12-member panel in this federal district court had to be unanimous.
Meanwhile, Steve Wolens, a lead attorney for the plaintiffs in the San Antonio case, says the verdict, if upheld, could soar way above the jury's $20.6 million finding.
Wolens says the ruling covered taxes on the OTCs' margins and it is still to be determined whether the OTCs owe occupancy taxes on their service fees, as well.
Wolens adds that the judge will determine how much to assess the OTCs in penalties and interest on that $20.6 million liability.
If the Anaheim, Calif., case, which is under appeal, is any indication, then the OTCs' liabilities could soar. For example, in Anaheim, Expedia Inc. faces an $8.2 million tax liability -- plus $9.5 million in interest and penalties.
After almost five years of lawsuits, this OTC hotel-tax drama hasn't neared its final act.