Ms. Gorman

Hospitality Law

Retail Management Agreements vs. Retail Leases: It's All About Control!

By Tara K. Gorman, Attorney, Greenberg Traurig LLP

It's simple. It's all about control! A retail management agreement typically provides a hotel owner with much greater control over the day-to-day operations of a retail facility than a retail lease does. The first question a hotel owner should ask is, "do I really want control over the day-to-day operations of the retail facility?" The answer may vary from facility to facility. For example, the hotel owner may not wish to delve into the day-to-day operations of the sundry shop, but the food and beverage operation, that may be quite a different matter because the food and beverage experience is closely tied to the overall guest experience.

There are pros and cons to each scenario, and the terms and conditions of the lease or the management agreement can be creatively structured to reach that fine balance between control and "hands off". Surprisingly, economics do not play into this issue as much as one would think.

What's the Difference?

Management Agreement: A management agreement is an agreement whereby the retail operator agrees to manage the retail facility 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 (i.e. control) 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.

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.

License Agreement: Another option is for the hotel owner to grant the retail operator a license to enter the retail facility and to perform specific acts therein. A traditional license provides a temporary privilege to the licensee and is revocable or terminable at the discretion of the licensor. While the license may offer hotel owners the illusion of maintaining flexibility and control over the hotel, the more a license resembles a lease by incorporating restrictions and provisions typically found in lease, the more likely a court will interpret a license as a lease and grant the licensee under the license the same rights as a tenant would be granted under a lease. In fact, in just such a case the court stated, "the parties' agreement contained many provisions typical of a lease and conferring rights well beyond those of a licensee or holder of a mere temporary privilege." Therefore, the court interpreted the license as a lease and the hotel owner ran up against landlord/tenant law. We will keep our analysis to the comparison between management agreements and leases.

Can I Kick Them Out?

Termination for Convenience:

Management agreements can be full of ways for hotel owners to "kick out" retail operators. The easiest way is to include a "termination for convenience" provision, whereby the hotel owner can terminate the operator "for any reason or no reason" upon a certain number of days' notice. While this seems like a great idea and leaves the hotel owner with a large amount of flexibility and control, it usually is a hard fought negotiation and ends up as a mutual provision which allows either party the right to terminate for convenience. The risk hotel owners face in this situation is that the retail operator can walk out with minimal notice and the hotel owner will have to scramble to find another retail operator. This may not be difficult in the case of a sundry shop operator, but it could be quite an ordeal to replace the food and beverage operator - especially in a five star operation with a "name" chef. Therefore, the amount of notice prior to the effective date of termination should be carefully considered so as to give the hotel owner enough time to get its duck a l'orange in a row, so to speak. In addition, along with a termination for convenience clause the retail operators typically require a termination payment to reimburse the retail operator for expenses incurred and opportunity costs lost. The termination payment is often reduced throughout the term. For example, if the hotel owner exercises its right to terminate for convenience within the second year of the term, the termination fee would be $1,000,000, but if the right is exercised later in the term the termination fee would be reduced with each passing year such that in fifth year of the term the termination fee would be $250,000. A lease does not typically provide the hotel owner with the termination for convenience option. A lease grants the tenant a real property interest which is not only governed by the four corners of the document, but is also governed by landlord/tenant law in the jurisdiction where the property is located. Typically termination for convenience is not contemplated in a lease and may be statutorily prohibited in the applicable jurisdiction.

Performance Test:

Another option to "kick out" the retail operator is a termination for failure of the retail operator to meet one or more performance tests. This option allows the hotel owner to terminate the retail operator if the retail operator is not operating the retail facility up to specific, objective standards and benchmarks set forth in the management agreement. For example, in the event the hotel owner engages a food and beverage operator to operate the restaurant, banquet facilities and room service at the hotel, the performance test may require that the restaurant be rated no less than a certain number for food and a certain number for service and d'ecor by Zagats or another rating agency. In the event that the food and beverage operator does not meet the criteria set forth in the performance test for the performance test period set forth in the management agreement, the hotel operator has the right to terminate the food and beverage operator. The performance test option is heavily negotiated in management agreements. Performance tests could be found in leases, but once again, as a lease grants an interest in real property, the hotel owner is up against landlord/tenant law, and this is not a typical route. That's not to say that a performance test couldn't be negotiated in a lease and enforced, but it just doesn't fit as easily into a lease as it does in a management agreement. The tenant is renting the space, and for sake of simplicity, as long as the tenant pays rent on time, it has a right of quiet enjoyment - i.e., it is statutorily granted the right to occupy the space without getting kicked out by the landlord. To incorporate a performance test into a lease, would mean to change the paradigm, and give the landlord a right that it traditionally does not have. So while a performance test is more typically found in a management agreement than in a lease, a savy hotel owner may require its tenants to endure a performance test - but beware, there will be push back from the tenant and a bit of work to shift the paradigm.

It's all about control!

A critical consideration for hotel owners is how well the retail facilities will be integrated into the rest of the hotel. Hotel owners want to provide a seamless guest experience through out all components of the hotel. A management agreement provides the hotel owner the mechanisms to hold the reins and control that experience. A management agreement sets forth the requirements of the day-to-day operations of the retail facility, and provides the hotel owner with the right to change its mind as to how the retail facility is operated, to terminate the retail operator for poor performance, and in the case of a termination for convenience, the right to kick out the retail operator "just because". Overall, the management agreement provides the hotel owner with a great deal of control. A lease provides the hotel owner with a modicum of control over the retail facility. For example, a lease may provide rules and regulations as to what sorts of activities are allowed in the retail premises and in the property as a whole. However, more often than not the rules and regulations do not reach the level of detail as the oversight set forth in a management agreement and the rules and regulation must be applied to all tenants in a non-discriminatory manner. Therefore, the rules must be one size fits all so that the sundry shop operator and the food and beverage operator must comply with the same set of rules.

This is just a sampling of how the a retail management agreement differs from a retail lease agreement. The bottom line is if the hotel owner desires a great deal of control over the retail facility, the management agreement is the best choice.

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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