The Evolution of the Hotel Management Agreement
By Tara K. Gorman Partner, Perkins Coie LLP | September 23, 2012
Co-authored by Nelson F. Migdal, Esq., Real Estate, Shareholder, Greenberg Traurig LLP
In the early days of the hospitality industry, there was no need for close scrutiny of a hotel management agreement because the owner of the hotel was also the hotel operator, and was either responsible for or personally performed the tasks of the receptionist, the bell staff, the house keeper, and the chief cook and bottle washer. That was then, this is now. In today's commercial environment, the ownership, operation and branding of the hotel, as well as its debt financing and capitalization, are in many hands, and each has its own separate and distinct set of interests. Those interests may not be in proper alignment all the time. This article, the first in a series, reviews the evolution of the hospitality industry, and how it relates to the evolution of the hotel management agreement and the owner-manager relationship. Future articles will address various aspects of the hotel management agreement, the evolution of the hospitality industry, and how the balance of power is reflected in each provision of the hotel management agreement.
Travel has been a part of life from the beginning of time. Even Mary and Joseph were foiled by the hospitality industry when they found "there was no room at the inn." In their infancy, hotels were simply private homes that offered rooms to the public for overnight lodging. The industry can thank the Roman Empire for expanding the hospitality business by encouraging the inns and hotels to cater to the pleasure traveler. Evidence of the first inn in America was recorded in 1607. And the industrial revolution resulted in the construction of hotels in Europe, England and America. From there the hospitality industry took on a life of its own.
The bifurcation of hotel ownership and operation initially took the form of hotel leases. Originally, hotel leases were much like any other traditional lease of property with a fixed rental rate with an annual rental rate increase. This gave the owner the security of a fixed rental income for the term of the lease, without any benefit or burden as to the profitability of the hotel. The lessee would take all of the financial risks in connection with the operation of the hotel These leases eventually evolved to a flat rental rate and a percentage of gross operating revenues or gross operating profits, to allow the property owner the opportunity to share in the profits of the hotel during a strong hotel market. The hotel leases resembled typical property leases and looked very little like the hotel management agreements of today.
The early hotel magnates - Kemmons Wilson (Holiday Inn), Conrad Hilton (Hilton Hotels & Resorts), Cecil B. Day (Days Inn) and Bill Marriott (Marriott International) - transformed the hospitality industry. In the beginning, these hoteliers owned the real estate, owned the hotel and brand, and managed the operation of the hotel. This resulted in a unity of ownership and operation. There was no need for a heavily negotiated hotel management agreement because the interests of ownership and operation were aligned and unified. This unity in ownership and operation progressed into the early franchise relationship. For example, Kemmons Wilson franchised the first Holiday Inn in 1957. Wilson's original goal was that his hotels should be standardized, clean, predictable, family-friendly and readily accessible to road travelers. By 1958 there were 50 Holiday Inns across the country - all standardized, clean, predictable, family-friendly and readily accessible to road travelers. The idea of predictability of the hotel brand revolutionized the hotel industry. The use of franchise agreements brings with it great advantages to the owner of the hotel, including access to the brand's marketing and sales force, reservation services, and a strong brand name when soliciting financing, yet allows the hotel owner to maintain independence in connection with the operation of the property. Some owners choose to operate their property independently, while others choose to hire a third party manager to operate their property.
The days of the grand hotelier and the unity of ownership and operation are all but gone. Hotel management agreements became widely used in North America in the 1970s. The bifurcation of ownership and operation as set forth in the hotel management agreement creates a careful balance of power. In the early days of hotel management agreements, the brand, with its operational expertise and brand affiliation, held the majority of the negotiating power and control over the process. Often, the individual owner had little to no hospitality industry knowledge or experience, resulting in hotel management agreements that were favorable to the hotel operator. During strong economic times, when both parties were making a profit and both parties benefited from the relationship, not much attention was paid to the balance of power and to which party was taking the greater financial risk. In weaker cycles, this imbalance of power became more evident. In time, owners became more sophisticated and began giving consideration to how hotel management agreements impacted the value of their hotel, and came to realize that maintaining certain control over their hotel is necessary to protect their investment.