Ms. Gorman

Hospitality Law

The Pitfalls and Pleasures of Joint Ventures Between Hotel Owners and Managers or Retail Tenants

By Tara K. Gorman, Attorney, Greenberg Traurig LLP

In the traditional hotel owner/operator relationship the lines are drawn in the sand and the roles are clear. Just as the titles imply - the hotel owner owns the hotel and the hotel operator operates the hotel. The hotel management agreement governs the relationship and that's that. When a joint venture enters into the equation, these lines are not so clear and which party is taking on which role at which time gets to be an interesting, and often complicated question.

Before a joint venture can be formed, several basic questions must be asked and answered. The first question is: what does each party bring to the table? Real estate? Management expertise? Retail or food and beverage expertise? Equity? Business savvy? The second question is: which entity will be the joint venture? The ownership entity, the management entity, or the retail entity. The third question is: what percentage of ownership interest is allocated to each party? And the fourth, and perhaps most difficult question is, what happens if the parties don't get along and have to break up as business partners? Once these basic questions are answered, the parties can get down to negotiating the governing documents -- and that's where the fun/confusion begins.

Governing Documents

Organizational Documents: The heart and sole of the joint venture is set forth in the organizational documents: the Operating Agreement of a limited liability company or the By-laws of a corporation. In a nutshell, the organizational documents deal with how the joint venture is run, how major decisions are made, how capital (or value) is contributed and distributed, and what happens in the event that the parties no longer desire to be business partners. This is where all the ownership considerations should be addressed.

Management Agreement: The management agreement is an agreement whereby the hotel operator agrees to manage the hotel on behalf of the hotel owner. Typically there is a definitive term, clear expectations as to the day-to-day operations, including layers of consent from the hotel owner prior to the performance of various activities and clear guidelines and options for termination of the operator, including termination for poor performance on the part of the operator. This is where all the operational considerations should be addressed.

Lease: A lease provides the tenant with an interest in real property, exclusive use and possession of the retail facility, and typically, unless there is a default of some magnitude which has not been cured within the applicable notice and cure period, a lease is terminated upon the expiration of the term set forth in the lease. While the hotel owner may have broad consent rights over such things as alterations to the premises and assigning the lease, beyond safety and cleanliness, the landlord typically has little say over the day-to-day operations of the retail facility. This is where the operational considerations should be addressed in a lease context.

License Agreement: In the event that the hotel or, for example, the restaurant, is branded, the license agreement grants the hotel owner a license to use the brand name, as well as the design, look, feel and operating standards of the brand. A traditional license provides a temporary privilege to the licensee and is revocable or terminable at the discretion of the licensor, as more specifically set forth in the license agreement. For example, if the hotel is not performing to the brand standards, the brand can terminate the license agreement and strip the brand from the hotel. This is where the issues relating to use of the brand should be addressed.

Types of Joint Ventures

Hotel Owner Joint Venture: The parties may decide to create a joint venture to act as the hotel owner. In this case, typically one party has expertise in hotel management, and the other owns the real estate. One party will contribute the real estate or equity and the other will contribute the management expertise and perhaps a minimal amount of equity. Typically the parties value the contribution of each party and then allocate the ownership interest accordingly. What gets tricky in this situation is that the hotel owner/hotel manager relationship is governed by the hotel management agreement, and the hotel owner consists of the traditional hotel owner (the party that owns the real estate) and the hotel manager. While on many aspects of the operation of the hotel their interests are aligned (hotel should be profitable), in other arenas, their interest are polar opposite (budget items and performance test). We'll get in to this more, when we discuss the pitfalls of joint ventures.

Hotel Manager Joint Venture: This is less common than the hotel owner joint venture. The basics are the same, but the end result is that the joint venture is the hotel manager. The real question in this context, is what does the owner of the real estate contribute to the joint venture? The hotel manager is hired by the hotel owner for its expertise in managing the hotel -- that expertise is contributed by the hotel manager portion of the joint venture.

Tenant or Retail Operator Joint Venture: In this case the joint venture is the Tenant or retail operator, such as the hotel restaurant operator or the spa operator ("specialty operator"). The parties to the joint venture could be the real estate owner and the specialty operator, or the hotel manager and the specialty operator.

Equity Partner Twist: In some cases one or more of the parties to the joint venture will ask an equity partner to join in its entity that holds ownership interest in the joint venture, or to directly join in the joint venture. In the second situation there is a third party sitting at the table. In first situation there is a third party not sitting at the table, but clearly influencing the decisions made by its partner who is sitting at the table. This results in a silent partner, who at times is not so silent and this leads to even further complications.

Pleasures of Joint Ventures

Aligned Interests: The interests of the parties are more likely to be aligned in a joint venture. Both parties want the joint venture to succeed. For example, if one party is the hotel manager, because it also holds an ownership interest in the hotel owner, it may think twice before it takes certain actions which would go against the interest of the hotel owner. Likewise, a hotel owner who is part of a joint venture which manages the hotel, will not as easily take actions to terminate the hotel manager as it would if it weren't part of the joint venture.

Risk Sharing: Another pleasure to the joint venture arrangement is that each party has a bit of "skin in the game". In this sense, each party is more likely to take the extra step or two to make sure that the hotel succeeds because not only are they sharing in the burdens, but they are sharing in the benefits.

Economic Burden Sharing: Not only does each party have some "skin in the game", typically, each party has some cash in the game. If the joint venture is the hotel owner, in the hard times the hotel manager can't just walk away without feeling a bit of the economic pain. On the other hand, when things are going well, the wallet of each party gets a bit fatter.

Combined Power and Know-How for Future Projects: Once the joint venture matures and has a few successes, the combined power and know-how is unstoppable and the parties can easily replicate the successes in future projects. They have worked through learning curve and it is easier to work together than with a new party -- this leads to a good working relationship and multiple projects.

Pitfalls of Joint Ventures

Potential Loss of Power: In a joint venture, as in a marriage, the parties must (or at least should) consider the other party before just "doing it my way". In the case of a specialty operator joint venture, the specialty operator may have years of expertise in the specialty area of operations, and now it has to consider the comments of its joint venture partner, unless of course, it was clever enough to carve out those sorts of operational decisions in its organizational documents (i.e., any decisions relating to the brand or the operational standards are to be made solely by the specialty operator).

Issues when Interests Conflict: When interests are aligned, all is right with the world, when interests conflict there is trouble in paradise. For example, if there is a brand involved, the brand has an interest in ensuring that its brand maintains its integrity, but when it is also a part of the ownership entity it has an interest in the success of the hotel. If the licensor under the license agreement pulls its brand from the hotel, the hotel will not succeed, but it if does not pull its brand from the hotel, the poor performance of the hotel will hurt the brand.

Change in Control Issues: The shift in power can bring on some complicated operational issues. This occurs when one party assigns its interest in the joint venture to a third party, or in the event the ownership interests shift such that the party holding the majority ownership interest initially, now holds the minority ownership interests. For example, when the owner of the real estate holds the majority ownership interest, it has the majority vote on all hotel owner decisions when it comes to the management agreement. This plays out like a traditional owner/operator relationship. When the power shifts and the hotel manager hold the majority ownership interest, often it has to "stand down" on some hotel owner decisions -- i.e., whether the hotel manager failed the performance test.

Greater Documentation as to Ownership and Operations: When a joint venture is involved, more documentation is necessary to ensure that each party is keenly aware of which hat it is wearing when it is making certain decisions. The negotiations of the governing documents can become very complicated because each party must keep in mind that while they are sitting at both sides at the table with various degrees of ownership interests and obligations, and that all of the documents are interrelated, each document must stand on its own, while at the same time contain cross default/termination provisions. For example, if a branded operator is operating the hotel, and the license agreement is terminated, the branded operator frequently requests the right to terminate the hotel management agreement because it doesn't want to be forced to operate hotel with a difference brand. All of these considerations must be carefully drafted in the governing documents.

This is just a sampling of the pleasures and pitfalls of joint ventures. The bottom line is joint ventures can create synergies and opportunities for each party; however, the governing documents must be carefully crafted to ensure that the roles of each party is clear despite the changing relationship over time.

Tara K. Gorman is a shareholder with the law firm of Greenberg Traurig. She focuses her practice on hotel acquisitions, operations, development and finance, condo hotels, hotel management agreements, and license agreement, general commercial real estate transactions, commercial leasing, various financing transactions involving lender and borrower representation. Ms. Gorman can be contacted at 202-530-8519 or gormant@gtlaw.com Extended Bio...

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