Mr. DeNapoli

Hospitality Law

Arbitration Clauses: Will They Work for You?

By Al DeNapoli, Partner, Tarlow Breed Hart & Rodgers, P.C.

While minor earth tremors are not unusual for California, in 1991, the California Appellate Court sent shockwaves across the fault line upon which Hotel management agreements rest when it issued its decision in Woolley v. Embassy Suites. The Woolley decision set the tenor for the way the courts, and consequently the industry, would view the legal relationship between hotel owners and management companies for the coming years. Essentially, Woolley stated that the relationship between an owner and its management company would be governed by principles of agency, where the owner is the principal and the manager is its agent. Over and above the contract relationship between them, the Court held the management company, like all agents, owes its principal fiduciary duties.

Even more earth shattering than the establishment of an agency relationship in these situations was the Woolley court's holding that when evaluating termination issues concerning a management company, agency principles will generally override interpretations which would otherwise control under contract law. Under this analysis hotel owners were found to have almost absolute power to revoke an agency relationship and terminate their management agreements despite contractual provisions to the contrary. While, in certain instances, management companies may be left with a damage claim, their ability to remain on the job and obtain an injunction to enjoin their termination was severely impacted.

The Woolley court points out, however, one important exception to this rule: an owner may be absolutely bound by the contract provisions regarding, among other things, termination rights, when the agency relationship is coupled with an interest. An agency coupled with an interest only occurs where the agent has a specific, present, and co-existing beneficial interest in the subject matter of the agency, (i.e. the hotels). The Court further states that for an agency to be coupled with an interest the agency must be created for the benefit of the agent in order to protect some title or right in the subject of the agency or secure some performance to him.(emphasis added).

In the majority of the cases, the agency relationship between the hotel owner and the hotel management agency derives from the Management Agreement under which the hotel management company is bound by a fiduciary duty to operate the hotel solely for the benefit of the hotel owners. Such agreements typically provide that the hotel management company will receive compensation for its services consisting of management fees or a percentage of the revenues. Because this compensation schedule does not constitute a specific, present, and co-existing beneficial interest in the hotels, the hotel management companies, in these scenarios, do not obtain a power coupled with an interest. Accordingly, in these situations management companies, like all other agents, serve at the pleasure of their principal and, without other factors being present, may be terminated at will.

Later cases involving termination issues have, in fact, placed the burden, and most usually a rather heavy one, on the management company to prove the agency relationship is somehow irrevocable. In order to meet this burden, management companies in these situations seek to have the courts look beyond the terms of the contracts to the actual relationship between the hotel owner and management company to determine the type of relationship that exists and the duties owed under that relationship. Consequently, a company, attempting to show that its termination was wrong, needs more than a mere recital that the contract recites that the agency relationship is irrevocable to be successful. Conversely, to maintain its right to protect its investment by terminating a management company it perceives is not working in its best interest, a hotel owner need be careful not to create a special relationship between it and its management company beyond the now recognized agency relationship.

Some courts have suggested, however, that a hotel management company may be able to negotiate terms in its management agreement with the hotel owner to limit the instances under which the agent can be terminated. In Government Guarantee Fund of the Republic of Finland v. Hyattt, the hotel management company, signed a subordination agreement in which the hotel owner agreed that the management agreement would remain undisturbed in the event of a foreclosure of the hotel so long as Hyatt was not in default. While the Court eventually held that Hyatt was properly terminated under the circumstances of this case, it also recognized that Hyatt successfully negotiated terms which provided that Hyatt could only be terminated if it was in default, and which provided that Hyatt could continue to manage the hotel even after a foreclosure sale so long as Hyatt was not in default.

Notwithstanding the ability of a management company to craft an agreement which will provide it with the additional security associated with an "agency coupled with an interest", the agent must remain vigilant of its duties to its principal when it continues to operate even after an attempted termination by the owner. After Hyatt lost in the case above on the issue of its right to continue its management of the hotel, the court found it did nothing, however, to modify its financial accounting procedures to make sure it would be able to make a full accounting to the Court and plaintiffs of its management and funds received. Thus, Hyatt ran the risk of not being able to satisfy one of the basic principles of agency that a breaching fiduciary must be able to establish that he paid to the principal or otherwise properly disposed of the money or other thing which he is proved to have received for the principal.

The agency relationship, underscored in the Woolley case and its prodigy, provides the opportunity, and the inherent risks, of creating new claims which parties may use against each other when the relationship ultimately fails.

In one such case, the hotel owners, attempted to use the agency relationship to form the basis of an antitrust claim against the hotel management company. Pursuant to the terms of the management agreement, the management company was given the authority to negotiate large-volume discounts with vendors seeking to supply hotels managed by its company. The owner based its lawsuit against the management company on the fact that the management company pocketed the rebates, or surcharges that it required its vendors to add for each purchase, despite, the fact, that it was allegedly duty bound to pass on the money to the owner.

The owner argued that it suffered an antitrust injury because it could only purchase goods from vendors participating in the management company's vendor program, and this caused it to pay artificially inflated prices for goods purchased through that program. The court found that the hotel owners adequately alleged an antitrust injury by showing that its agent deprived the hotel owners of rebates and payments to which they were entitled and caused them to lose business vis-`a-vis their competitors because they paid higher prices for the hotel supplies, but that due to tensions between different parts of the agreement it was necessary to do some fact finding about the specific details of the relationship between the hotel owner and hotel management company, the context and nature of the alleged rebates and payments received by the hotel management company, the course of dealing of the parties, and the standard of practice in the industry.

While the owner's claim in this case was ultimately dismissed due to its inability to establish that it suffered an antitrust injury, the Court did concede that any injury the owner suffered was caused by a breach of contract and the corruption of the principal-agent relationship and that under certain circumstances an antitrust claim could flow from "the corruption of an agency relationship." Although the Court in this case could not definitively decide on the antitrust issue due to conflicting provisions in the management agreement, it again lays the groundwork for future claims by demonstrating that Courts may be open to the possibility of basing even an antitrust claim on the agency relationship.

The Courts clear willingness to consider the permutations of the various relations, including fiduciary and agency obligations and those created under the contract, and the facts surrounding the underlying obligations of parties to hotel management contracts underscores the importance to hotel management companies and hotel owners to be more mindful of the terms negotiated in their management agreements. It may also go without saying that to protect against the expense of money and time lost in litigation, these parties need to be more attentive to the day-to-day relationships that they maintain with each other.

Al DeNapoli is a partner of Tarlow Breed Hart & Rodgers, P.C. He is chairman of the hospitality practice group and provides expertise on franchising, leasing and licensing to clients ranging from national chains to local restaurants and lodging owners. He also concentrates in civil litigation, including complex business contracts, shareholder disputes, and employment problems. He is a member of the Massachusetts Lodging Association and was recently named to the Massachusetts Restaurant Association board of directors. Mr. DeNapoli can be contacted at 617-218-2024 or adenapoli@tbhr-law.com Extended Bio...

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