Emerging Trends: New Focus in Hotel Management Agreements By Ellen S. Smith
Hotel owners and operators should take note of newly evolving ways of looking at management contract issues. While some points in hotel management agreements, such as fee structure, have always been highly negotiated, a number of other issues have more recently emerged as the focus of much attention for hotel owners and operators. Factors such as the changing role of technology in hotel operations and the dynamic market forces driving hotel performance have caused owners and operators to reevaluate contract provisions once thought adequate. This article highlights a few of the more prominent current trends in thinking of hotel owners and operators. The growing role of technological systems in hotel operations has forced more attention on issues such as which party owns guest history information, particularly relating to corporate and group accounts, with respect to the hotel. The ability to obtain full guest history information is of crucial importance to potential hotel purchasers who are buying not only real estate but also an ongoing business, and yet many buyers are told – and accept – that such information is not available to them. Hotel owners are often unable to assure transfer of all guest history information to hotel buyers because that information, while legally owned by the hotel owner, is completely under the control of the hotel operator and often stored in a "cluster" or "complex" of information and systems for multiple properties managed by the operator. Not surprisingly, most hotel management agreements, particularly agreements for major brand operators, are either silent on the issue of guest history information or provide that the guest history information is the property of the operator. This void allows an operator to simply refuse to turn over guest history information to a buyer of the hotel. Some hotel owners have averted this problem by negotiation of management agreement provisions requiring the operator to agree that such information is the owner’s property and will be provided to any purchaser of the hotel. In turn, many operators will resist such a provision, and some owners may agree to give up this point in the negotiation process in favor of issues that the owner considers more immediately important. On a related note, hotel owners also want the management agreement to obligate the hotel operator to cooperate with a buyer regarding certain other technological issues if the management agreement is terminated in connection with the sale of the hotel. In the absence of an affirmative covenant to cooperate, a hotel manager may be less than willing to assist with respect to the transfer of the operation of the hotel upon such a termination. While management contract language regarding changeover of operations has lagged decades behind the technological systems and information that are crucial to such operations, hotel owners have more recently caught on to the need to update such contract provisions. More and more management agreements are requiring the outgoing operator to follow negotiated transition procedures for the turnover of the hotel’s books and records to a buyer and for the switch of the hotel’s operating systems. From its perspective, however, the operator will be concerned that its
proprietary information is not revealed to the buyer and that any such obligation to cooperate is limited in terms of time and cost. On the performance test front, the parties to management agreements are paying more attention to the crafting of standards that accurately measure the performance of the hotel operator. For example, past methods of defining the competitive market for a particular hotel were too often static and left little room for reevaluation. Newly emerging hotel brands, as well as changes in hotel standards due to frequent brand acquisitions or repositionings, mean that the “competitive set” against which the performance of a hotel is measured may need to be revisited several times during the term of a management agreement. As a result, many hotel operators insist on elaborate provisions for determination and redetermination of the group of properties that most directly compete with the hotel, as well as dispute resolution mechanisms in the event the parties fail to agree on such issues. The operator may also be held to performance standards based on achievement of certain projections of profit, net operating income, return on the owner’s investment or similar benchmarks. In such case, the owner will want to ensure that the performance test is based on the budget originally approved for the fiscal year in question and not the budget as revised by the operator to take faltering performance into account. For its part, the operator will push to exempt from any performance test changes in the hotel’s performance caused by events outside of the operator’s control. While this type of exception is reasonable in the general sense, an owner should tread carefully through this type of negotiation, or the result may be a gaping “force majeure” loophole in the performance standards to which the operator can be held. Owners are also imposing some limits on the rights of an operator to cure any performance test failure. Historically, major brand operators were able to negotiate the right to “cure” any such failure by making certain payments designed to bridge the gap between actual performance and minimum passing performance. It has become more common for owners to limit the right to cure only to a certain number of times during the term or to require that cure payments exceed the minimum acceptable standard by certain measures rather than just meet the standard. Owners and operators have also become more creative in crafting other modes of cure, such as deferral or forfeiture of future incentive management fees. Greater leverage in favor of hotel owners in the performance test arena has also prompted some owners to negotiate an increased role in major decisions affecting the hotel’s operations. For example, while it is common for a management agreement to allow the owner some input into the hiring of the hotel’s general manager, more and more owners now have veto rights over the decision to hire or fire a general manager and certain other executive personnel of the hotel such as the sales manager and food and beverage director. Also, many owners are now exercising greater leverage in the budget approval and revision process. An owner should take care, however, that too much involvement in operational matters does not enable the operator to blame poor operating performance on interference by the owner. Owners and operators are also paying new attention to provisions relating to the sale of the hotel. In the past, it was more common for the owner to negotiate a right to terminate the management contract, upon payment of a fee, in the event the owner sold the hotel to a party that did not wish
to assume the management agreement. While such owner termination rights are still the norm, hotel management companies are also exercising leverage in this area. Not only are more management agreements granting the operator the right to elect termination if the owner transfers the hotel or a controlling interest in the owner, but many operators have been successful in negotiating rights of first offer or similar priority rights to negotiate to acquire the hotel in the event the owner wishes to sell. Rights of first refusal in favor of an operator remain relatively uncommon. As the balance between hotel owners and operators continues to shift in response to economic, technological and other forces that shape their relationship, new ways of addressing old issues in hotel management contracts will doubtless continue to emerge. Historically “standard” management contract language may not always be sufficient. Owners and operators need to stay attuned to such forces in order to ensure that their management agreements adequately address their concerns.
Ellen Smith, Counsel at Sutherland Asbill & Brennan LLP (www.sablaw.com) in Atlanta, Georgia, focuses her practice on hotel acquisitions, development and operations. Ellen was previously an attorney with InterContinental Hotels Group. Please contact ellen.smith@sablaw.com for further information.