Mr. Migdal

Hospitality Law

Hotel Law: Emerging Issues for the Hospitality Industry

By Nelson Migdal, Real Estate, Shareholder, Greenberg Traurig LLP

The hospitality industry as a whole, and various sectors within the industry in particular, continue to face challenges arising from changes in the local, regional, national and international marketplace. We will identify and briefly discuss some of these emerging issues.

The Hotel Management Agreement

The hotel management agreement is the primary document governing the relationship between the hotel owner and the hotel operator or manager. Even in the franchise arena there are often hotel management agreements that govern the management of the hotel for the owner. In this case the management agreement gives the owner a bit more flexibility by allowing the owner to add its own structure on top of the structure provided in the franchise agreement. Therefore, the hotel would be managed in accordance with both the management agreement and the franchise agreement. Because the management agreement is the vehicle for so much of what governs the parties, the agreement itself becomes important in considering emerging legal issues.

Which Party is the Employer of the Hotel Employees?

One of the big issues for hotel owners is which party is the employer - the owner or the manager? There are pros and cons to each scenario, and the terms and conditions of the hotel management agreement with respect to employees and employment matters must be well thought out and leave no room for error. Because so many owners these days are REITS, private funds, insurance companies, and other institutional owners, the entire employee and employer relationship must be closely examined. Surprisingly, economics do not play into this issue as much as one would think. Typically, the owner is responsible for the costs of employment as an operating expense of the hotel regardless of which party is the employer. Similarly, the issues of imputation of liability for the conduct of certain employees are often the same regardless of which party is the employer. What tips the scale will vary based upon many factors, and the applicable law of the jurisdiction in which the hotel is located.

Performance Test Termination

Another hot issue in hotel management agreements is the performance termination test. Without a performance test termination the owner may have no right to terminate a poorly performing hotel manager. For example, the hotel manager may not be managing as expected by the hotel owner, but the poor performance may not rise to the level of an "event of default" under the hotel management agreement which would trigger an owner termination right.

More and more owners are insisting on some sort of performance test termination. Typically, the performance test does not kick in until the hotel has had a chance to stabilize and work out the kinks of a newly operating hotel. The length of time for stability varies from hotel to hotel, but typically it is anywhere between one and three full fiscal years after the opening date. After the stability period, the time period for the performance test may be one or more years.

The performance test can contain as little as one element or as many as a series of elements which the manager must pass. One element which is typically in performance tests is the requirement that the actual gross operating profit reaches at least a certain percentage of the gross operating profit set forth in the annual budget for such performance test period. While this may seem "self selective" at first glance because the manager typically presents the annual budget to the owner for approval, the owner must approve the annual budget before it is effective; therefore, if the threshold is too low, the owner would not approve the annual budget. Another element which is often used in a performance test is that a certain profit must be distributed to owner during the performance test period. This profit often is characterized as owner's preferred return and is typically tied to the financing of the hotel. For hotels which are rated by rating agencies such as Smith Travel Research, an element typically used in the performance test is a comparative test to see how the hotel stacks up to similar hotels in the market in which the hotel is located. Typically, the set of similar hotels is specified in the hotel management agreement as the "competitive hotel set". For the comparative test, the revenue per available room ("RevPAR") for the hotel must be no less than a certain percentage of the annualized average RevPAR of the competitive hotel set for each fiscal year in the performance test period. In some cases the failure of one element is enough to trigger owner's right to terminate, and in other cases the manager must fail all elements in the performance test before the owner's right to terminate is triggered. As you can imagine, the performance test is heavily negotiated in the hotel management agreement.

One interesting twist to the performance test is the "do over" clause. This is where the manager has the right to literally pay for its mistakes. This is typically only tied to the gross operating profit and owner's preferred return elements of the performance test. The way the "do over" clause works is once the owner has exercised its right to terminate the hotel management agreement, if the manager provides owner a payment for the deficit in the hotel's achievement of the element of the test which the manager failed, then the manager will be deemed to have passed the performance test and will continue to manage the hotel. So, literally the manager is able to pay for its mistakes and continue managing the hotel.

Licensing and Geographic Exclusivity

There are many very familiar "brand" names of hotels and national hotel operating companies. Whether or not a hotel carries a "flag" "franchise" or "brand" is one important factor to consider along with the location of the closest hotel with the same flag. The flag impacts everything. The financial health of the hotel today and in the future as a result of the management of day-to-day operations of the hotel, the inventory of personal property that is sold along with the physical structure of hotel, collective bargaining agreements with unions, such as UNITE-HERE, unfunded pension liability, and intellectual property rights are all relevant.

The debate of geographic exclusivity is another emerging trend. Clearly an owner of a brand name hotel does not want the franchisor or licensor to license its brand to another hotel on the same block, down the street, or even in the same city. The location of the closest hotel with the same flag will greatly impact the value of the owner's hotel. Therefore, sophisticated hotel owners are requiring that that the franchisor or licensor provide the hotel owner comfort that its hotel will be the only hotel in that area - at least for a period of time.

Exclusivity provisions generally have two components - time and distance. For example, the license agreement may provide that for a specific period of time the licensor may not license the brand name in connection with the ownership, development, sale, marketing, advertising, promotion or operation of any other hotel within a specific area. In fact, the exclusivity provision may be even exclude the mere announcement of any affiliation with any hotel within the exclusivity area.

There are a variety of ways in which exclusivity provisions can be configured. In some instances once the time period is over, the exclusivity right terminates and the licensor may license the brand to a hotel right next door. In other instances, the exclusivity right may start with a large area and after a certain period of time the exclusivity right will only apply to a smaller area, but that exclusivity right would run as long as the license agreement is in full force and effect. In other instances, the type of exclusivity may be split into several different categories. For example, if the licensor is licensing its brand to the owner of a traditional hotel, the exclusivity provision may be split into three categories each with its own time and distance parameters: (1) traditional hotel, (2) condominium hotel, and (3) residential project.

It is critical for both parties to be careful during the negotiation of the exclusivity provision. Without a strong exclusivity provision, there is no guaranty that the franchisor or licensor will not license its brand to the hotel next door or across the street. While the franchisor or licensor will argue that this would "cannibalize" their profits under the existing agreement with the owner, if a developer approaches the franchisor or licensor with a project with twice the number of room keys over the owner's hotel, the temptation for the licensor or franchisor may be too great. An exclusivity provision would protect the owner from just this chain of events -- at least for a certain time and within a certain distance.

While the hospitality industry continues to face challenges arising from changes in marketplace, with each passing day hotel owners and managers are becoming more sophisticated in protecting their interests.

This article was co-authored by Tara Gorman. Ms. Gorman is a Shareholder at Greenberg Taurig. She focuses her practice on general commercial real estate transactions, including commercial real estate acquisitions and sales, hotel acquisitions, operations, development and finance, office leasing, various financing transactions involving lender and borrower representation and telecommunications and access matters on behalf of building owners and managers.

This article was co-authored by Sarah Davis, Associate, Greenberg Taurig. Ms. Davis focuses her practice in Real Estate. Sarah is experienced in various general commercial real estate transactions, including office and retail leasing, sales and acquisitions and lender representation. Other areas of experience include negotiation of telecommunication access agreements and various financing transactions involving commercial mortgage-backed securities.

Nelson F. Migdal is a Principal Shareholder at Greenberg Traurig and head of the Mid-Atlantic Real Estate practice group. He has practiced hospitality law for over 25 years. He handled the management agreements for The Echelon Place, in Las Vegas. In Panama, as owner's counsel, he obtained the first "Trump" license in Central America. Nelson is owner's counsel for The Trump Soho Project, and handled the Exclusive License with Trump in Istanbul. Nelson is an officer of the Academy of Hospitality Industry Attorneys and a member of the International Society of Hospitality Consultants. Mr. Migdal can be contacted at 202-331-3180 or migdaln@gtlaw.com Extended Bio...

HotelExecutive.com retains the copyright to the articles published in the Hotel Business Review. Articles cannot be republished without prior written consent by HotelExecutive.com.