Mr. Brewer III

Hospitality Law

Territorial Restraints: The Legal Landscape for Today and Tomorrow

By William A. Brewer III, Co-Founding & Co-Managing Partner, Bickel & Brewer

Question 1: What Is The Parties' Legal Relationship?

The first question that hotel owners and operators should ask is, "What is the parties' legal relationship under the management agreement?" Since the seminal decision in Woolley v. Embassy Suites, Inc., 278 Cal. Rptr. 719 (Cal Ct. App. 1991), courts have routinely agreed that the hotel operator is an agent of the hotel owner. As an agent, the operator has common law fiduciary duties, including a duty of loyalty that bars it from competing with the owner. It is no surprise, therefore, that courts frequently view a contractual territorial restriction as imposing a fiduciary duty of loyalty on the management company.

Because the relationship between the owner and operator is defined by their contract, the parties are free to bargain away some or all fiduciary duties that the operator may normally owe the owner, including the duty of loyalty. It can be expected, therefore, that management and hotel companies will continue to seek contracts with owners that contain "no-agency" and "no-fiduciary" disclaimers. However, it is not enough to simply purport to waive or disclaim all agency obligations, or to put another label on the operator (e.g., "independent contractor"). Disclaimers will not be effective unless they specifically and clearly state that the manager owes no duties to the hotel owner apart from those specifically enumerated in the contract. Courts have also routinely dismissed language in management contracts disclaiming agency when the facts of the actual relationship between the parties establish that that operator is - despite the disclaimer - acting as the owner's agent.

In addition to the agency issue, the parties to the management contract need to be clear about which particular entities are subject to the territorial restriction. Take the common situation where the operator is an international company whose portfolio includes a number of different recognized brands. The operator may intend that the territorial restriction be limited to its involvement with only those hotels that operate under the same brand name as that of the owner. The owner, on the other hand, may view the provision as barring competition not just from similarly flagged hotels managed by the operator, but also from hotels that are affiliated in any way with the operator, be it through a parent company, subsidiaries, other brands within the operator's corporate umbrella, or even joint venture partners.

Consider another situation, wherein a worldwide hotel company uses a form territorial restriction in all of its management agreements that prohibits both the company and its "subsidiaries" from competing with the owner of a hotel that the company manages. What if the company is later wholly acquired by another operator? It should be anticipated that, in such an instance, hotel owners will argue that the territorial restriction bars not only competition from hotels managed by the original company and its subsidiaries, but also any existing hotels that the acquiring operator and its subsidiaries are already managing within the owner's "territory." That could impose unanticipated and steep costs on any planned acquisition.

Question 2: What is the Intended Scope of the Territorial Restriction?

The second question that hotel owners and operators should ask is, "What is the scope of the territorial restriction?" The determination of this requires careful thought and planning in order to avoid unexpected pitfalls. Accordingly, the parties should strive to precisely define the geographical boundaries of the territorial restriction. For example, stating that the territorial restriction covers "Dallas, Texas" may leave open whether the restriction covers the City of Dallas, the County of Dallas, or both. However, as hotel and management companies consolidate operations across multiple brands, develop boutique "brand extensions," and enter into "co-branding" relationships with non-hotel partners, agreeing on what the "territory" is may not be as simple as defining map coordinates.

For example, a territorial restriction may dictate that a hotel company cannot "use" a brand's name, mark, or logo to "operate" another hotel within a defined geographical territory. The company may view this limitation as encompassing only the tangible use of such items (e.g. the brand name on a hotel building, or the logo on a press release) at another hotel physically located within that territory. It would thus be otherwise permitted to use and leverage the brand's name, mark, or logo - and their perceived cache among guests, travel agents, and the trade media - to publicly endorse a joint venture partner that intends to build another hotel, under another name, within that same territory. Indeed, it might feel free to use any of these items to assist the joint venture in developing and marketing the new property, as long as those efforts do not originate or manifest themselves within the defined territory. The owner, however, could have a decidedly different interpretation of the relevant territorial scope of the terms "use" and "operate" in this context. It may argue that the territorial restriction is a clear promise by the hotel company that, within the provision's defined territory, it is the owner's hotel that is the exclusive recipient of the valuable tangible and intangible benefits that are part and parcel of the brand's name, mark and logo. It may contend that this promise is broken, for example, each time that the hotel company publicly links the brand's name with any other property located within that territory, even if such linkage itself occurs only outside the territory (e.g., in statements made to the trade media via corporate press releases.) Or, if the hotel company uses the brand's name, mark, or logo to market the new property to national and regional travel intermediaries, or to solicit guests for the competing property through the company's web-based reservations system. Thus, in determining what the scope of a territorial restriction will be, owners and operators should consider all of the possibilities for potential competition that may arise between them in the global marketplace.

The question of whether a management company is wrongly competing with the owner thus takes on more complexity when management agreements involve hotel companies that own and manage multiple brands. As a basic example, a territorial restriction may dictate that the hotel or management company cannot "operate" another hotel within a specified geographic area. The parties to such a provision should ensure that they understand what each intends by the term "operate." The operator may intend that it only be restricted from directly managing another property that does business within the specified geographical area. The owner, however, may be of the view that the restriction is broader in application, and prohibits the operator not just from actively managing another hotel in the restricted area, but also from franchising, marketing, or even providing reservation services for any other hotels within that area.

This example highlights a potential source of friction between owners and operators that is poised to repeat itself in the emerging competitive environment. In interpreting the scope of the activity being limited by a territorial restriction, management companies will most likely seek to narrow the application of terms such as "operate" or "manage" as much as possible to the actual, on-site services and personnel they are providing to the owner. Owners, on the other hand, can be expected to contend that the "operation" and "management" of their properties involves much more, and includes, for example, the operator's provision of global marketing efforts, worldwide reservations systems, and corporate-level operational and financial expertise. The territorial restriction, owners will argue, thus also limits or prohibits the operator from granting the benefit of these services to other hotels within its defined territory. Given that many hotel companies are looking to centralize tasks - such as administration, training, marketing, and reservations - across their multiple brands in an effort to maximize business synergies and efficiencies, the parties should be mindful of these different viewpoints when negotiating the terms of any territorial restraint.

Another consideration is that, while activities that are not expressly prohibited by a territorial restriction may generally be deemed to be implicitly permitted, the operator is nevertheless still barred from engaging in conduct that would be contrary to the provision's purposes and the owner's legitimate expectations. This distinction might arise, for example, with regard to an operator's use of sales, demographic, and other business or financial data that it collects pursuant to its role as manager of the owner's hotel. Even if a territorial restriction only barred the operator from managing another hotel that flies the same flag as that of the owner's hotel within its defined territory, the owner may still contend that the operator cannot - without the owner's express authorization - use such data to assist other branded hotels in that territory that compete with the owner, because the very purpose of the territorial restriction is to limit such competition. The parties should make every attempt to anticipate such possibilities, and to clarify what particular activities are being addressed by the territorial restriction.

Question 3: If the Owner is Harmed, What Are the Remedies?

The third question that hotel owners and operators should ask is, "What are the remedies potentially available to an owner that is harmed when an operator breaches the territorial restriction?" Put another way, what are the potential consequences when operators wrongly compete with the owner within the restricted territory?

Because the operator will most likely be seen as the owner's agent, its breach of the territorial restriction will also be considered a breach of its fiduciary duty of loyalty. In such cases, the owner may have a common law right to immediately terminate the management agreement. That right would be in addition to the owner's right to sue for compensatory damages, or any other contract remedy it has. In addition, the owner may seek the equitable remedy of disgorgement, pursuant to which the operator may be forced to return all or a portion of the fees that it was paid by the owner during its period of disloyalty.

Even in those cases where the management agreement effectively disclaims an agency relationship between the parties, the owner would still have the option of suing to specifically enforce the territorial restriction, to collect compensatory damages, and for an injunction aimed at immediately stopping the competitive behavior and preventing its reoccurrence. Alternatively, the owner could seek to immediately terminate the management agreement by characterizing the breach of the territorial restriction as a "default event" under the contract. In either event, the operator would be left between the proverbial "rock and a hard place," in that it would be forced to reconcile its existing, but now contradictory, contractual obligations to both the successfully litigating owner and the owner of the competing hotel.

Of course, the goal of the parties to any management contract is to avoid such outcomes. That possibility is greatly enhanced when both the owner and the operator have a clear understanding of what their legal relationship is, the precise scope of the territorial restriction, and the potential consequences if the territorial restriction is breached.

Kenneth N. Hickox, Jr. contributed to this article.

William A. Brewer III is co-founding and co-managing partner of Bickel & Brewer, with offices in Dallas and New York. Under Mr. Brewer's direction, Bickel & Brewer has become renowned for its innovative handling of disputes within the hospitality industry. For the past decade, Bickel & Brewer has represented hotel franchisors, management companies, owners, developers and investors in the highest profile litigation in the hospitality industry. He is a member of various philanthropic organizations, including the New York City Partnership and the Board of Trustees of Albany Law School. Mr. Brewer III can be contacted at 214-653-4811 or wab@bickelbrewer.com Extended Bio...

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