Mr. Sullivan

Hospitality Law

The Tale of an Ousted Hotel Manager - Understanding the Mal-Alignment of Interests of Hotel Owners and Hotel Managers

By Michael Sullivan, Shareholder, Greenberg Traurig

The facts of the Turnberry Case are more like something we’d see in a James Bond movie than in real life. But then again, fact is stranger than fiction. In real life can a hotel manager be ousted from a hotel without notice and cure - even with a carefully crafted hotel management agreement in place?

Despite the view by some that modern hotel management agreements provide hotel managers with “protectable interests coupled to their agencies” that should prevent hotel owners from ejecting the hotel managers from the hotel, the recent opinion of Magistrate Judge Jonathan Goodman in FHR TB, LLC, et al., v. TB Isle Resort, L.P., (i.e., the Turnberry Case), brings us back to legal reality. On August 28, 2011, the owner of Turnberry Isle Resort & Spa evicted the hotel manager, Fairmont Hotels and Resorts, from the Turnberry resort, without notice and the opportunity to cure. In this “surprise takeover” the hotel owner informed Fairmont’s senior hotel management team that the hotel owner was de-branding the resort, and demanded that Fairmont leave the hotel property escorted by security.

Shortly thereafter the hotel owner sent Fairmont a letter stating it was terminating the hotel management agreement. The hotel owner further stated that under New York law a hotel owner always has the right to revoke a hotel manager’s control of the hotel because a hotel management agreement creates a “revocable” agency relationship. After being kicked out of the hotel, Fairmont stated that the hotel owner acted in bad faith and blatantly violated the hotel management agreement. Fairmont brought its claim to Judge Goodman and requested injunctive relief in order that Fairmont could continue to manage the resort and return to the status quo. While Judge Goodman was sympathetic to Fairmont’s predicament, he was simply tasked with determining whether Fairmont’s agency relationship was irrevocable and capable of specific performance - i.e., was the hotel owner required to take Fairmont back as the hotel manager?

Judge Goodman’s opinion provides a scholarly overview of the law governing hotel management agreements. Judge Goodman concludes (applying New York law) that the hotel management agreement in question between Fairmont and the owner of Turnberry Isle Resort & Spa forms an agency relationship that may be “revoked” by the owner even if doing so constitutes a default on the part of the owner. Despite the fact that the hotel management agreement in the Turnberry Case contained carefully crafted provisions purporting to prevent the owner/principal from terminating the hotel management agreement, Judge Goodman found that the agency relationship may be revoked by the hotel owner.

In his ruling, Judge Goodman painstakingly evaluated each Fairmont claim that its agency relationship should be deemed “coupled with an interest” and therefore irrevocable. If a hotel management agreement is considered “coupled with an interest”, the hotel owner would not have the “power” under the law of agency to unilaterally terminate the hotel management agreement unless the hotel manager defaults, fails the performance test or is otherwise subject to termination in accordance with the terms of the hotel management agreement. If an agency is coupled with an interest, an owner can’t just evict the hotel manager without cause - and even with cause, the hotel owner must fully comply with the termination provisions of the hotel management agreement.

Included among the indicia that Magistrate Goodman rejected as a basis for forming a “coupled interest” are Fairmont’s rights of first offer and first refusal, rights of quiet enjoyment and provisions in the hotel management agreement claiming to provide for a “coupled interest”. That just wasn’t enough. Magistrate Goodman also concluded that “consideration” for the hotel management agreement alone, was insufficient: “Consideration is necessary to make an agency irrevocable, but an agency coupled with an interest must still be present for consideration to render the agency irrevocable.”

So where does this leave owners and hotel managers? From the standpoint of hotel management agreement jurisprudence, in the absence of applying Maryland law as the law governing the hotel management agreements, which, among other things, purports to eliminate the hotel owner’s power to revoke the management agreement, we are back to 1991 with the case of Woolley v. Embassy Suites, (the “Woolley Case”). Despite statements to the contrary in a hotel management agreement, a thoroughly prepared hotel management agreement, which provides “exclusive” operating control to the manager (even subject to budget constraints), forms an agency relationship. And in the absence of the manager holding a specific, present property interest in the hotel itself (i.e., owning a percentage interest in the entity that owns the hotel), the agency is not “coupled with an interest”. Based on the well-reasoned opinion of Magistrate Goodman in the Turnberry Case, the law governing hotel management agreements is the same today as it was 20 years ago when the Woolley Case was decided, and that view has remained consistent since.

Although instances of owner “ejection” of hotel managers in the manner evident in the Turnberry Case are rare, they are a byproduct of what can be considered a deliberate mal-alignment of interests between the owner and the manager. Sophisticated owners and managers (particularly branded managers) understand what changes could be made to the hotel management agreements to better align their interests. On the manager side, the manager could agree to (i) reduce its base management fee to a percentage of top line revenue that is sufficient to recoup only manager’s true cost of delivering the service, (ii) receive more of its compensation through the incentive management fee, (iii) provide for the automatic reduction of budgeted Departmental Expenses and Undistributed Expenses in proportion to the percentage declines in budgeted gross revenues, monthly in arrears, in order to maximize net operating income, and (iv) readily permit sale termination after a reasonable lock-out period (e.g., 5 to 7 years). These sorts of changes would more closely align the manager’s interests with the owner’s interests, thereby reducing but not eliminating the chances of a Turnberry-style surprise “revocation” of the hotel management agreement.

Conversely, hotel owners could agree to better align their interest with managers by (i) offering the manager a greater likelihood to earn larger incentive management fees in exchange for a reduction of the base management fee, which is calculated on Total Revenues, and (ii) providing some form of post-termination security to compensate the manager for termination damages if the hotel management agreements is terminated by a foreclosure resulting from leverage in excess of agreed upon loan-to-value percentages or the hotel management agreement is terminated unilaterally by the owner in a Turnberry-style revocation.

Over the last 20 years we have come to understand the legitimate reasons to resist these types of reforms. The branded manager’s enterprise value depends on long-term contracts with higher fixed fees calculated on top-line revenues and they fear potential brand degradation resulting from budget constraints tied strictly to monthly profitability. On the other hand, having taken the investment risk, owners are reluctant to surrender a substantial portion of operating profits to manager incentive management fees and unwilling to share sale proceeds (except for modest fee multiples) as an inducement to obtain more liberal sale termination rights.

These are not novel reforms. However, because of the known consequences of these reforms they have not been embraced by hotel owners and managers. Until these sorts of reforms are embraced, the agency relationship between hotel manager and hotel operator will not be seen as an agency coupled with an interest, and occasionally real life will be stranger than fiction and we should expect the occasional Turnberry-style eviction.

Michael Sullivan is the co-Managing Shareholder of the Orlando office of Greenberg Traurig and is the co-Chair of Greenberg Traurig’s Hotels, Resorts and Clubs Practice Group. Mr. Sullivan specializes in the representation of real estate developers, national hotel chains, lenders and owners in the purchase, development, finance, leasing, operation, management and licensing of hotels, condo-hotels, and resorts. He has extensive experience in the negotiation of both public and private hotel management contracts and has negotiated public/private ventures on behalf of hotel companies and owners with local governments and publicly owned convention centers. He has extensive experience in hotel insolvency proceedings including loan work-outs, foreclosures and bankruptcies. In addition, Mr. Sullivan’s practice includes development of complex mixed use real estate developments and the purchase, sale and financing of retirement communities, medical office buildings and senior living communities. Mr. Sullivan received his Juris Doctor degree, with Honors, from the University of Connecticut School of Law in 1984 and his Bachelor of Arts degree in 1980 from Yale University. Mr. Sullivan can be contacted at 407-420-1000 or sullivanm@gtlaw.com Extended Bio...

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