Arbitration Clauses: Will They Work for You?

By Al DeNapoli Partner, Tarlow Breed Hart & Rodgers, P.C. | February 20, 2010

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.

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