Hotel Management Agreements and Bankruptcy
By Tara K. Gorman Partner, Perkins Coie LLP | April 19, 2009
The First Inquiry: Acceptance or Rejection of the Hotel Management Agreement
When a hotel owner files for bankruptcy, the bankruptcy trustee may reject any contract of the debtor (i.e. the hotel owner), including the hotel management agreement. In simple terms, in bankruptcy, accepting a contract means keeping the contract alive and in full force and effect and rejecting a contract means ending the contract to minimize the financial impact of the contract. There are a few statutory exceptions to this blanket rule. While some hotel management agreements may contain an automatic termination provision in the event either party files for bankruptcy, this type of provision is not always enforceable under bankruptcy law.
Trustees can only reject contracts which are "executory", meaning that both parties to the contract have continuing obligations under the contract. If the services have been rendered by the hotel manager, and the only outstanding obligation is payment by the hotel owner, a contract cannot be rejected because even though the hotel manager has no more obligations the hotel owner continues to have an obligation to pay the hotel manager. Since, however, hotel management agreements are generally long-term contracts and the obligations are of an on-going nature, the applicability of this exception is rare. In fact, it would be nearly impossible to find a situation whereby the hotel management is in full force and effect and there are no continuing obligations by either party. Consequently, hotel management agreements are predominantly accepted by the bankruptcy trustee.
Factors Affecting Whether to Reject the Hotel Management Agreement
Bankruptcy trustees have a fiduciary duty to the estate and, accordingly, should only reject the hotel management agreement if it is in the estate's best interest to reject the hotel management agreement. There are many factors that come into play when making this determination. These factors include anything from the strength or weakness of the hotel flag to an economic downturn to a costly mistake by the hotel manager.
In some cases, it would be beneficial to the estate to keep the hotel management agreement in place, i.e., accept the hotel management agreement. Internationally known hotel flags allow the hotel to attract guests and bring in a steady stream of revenue, and rejecting a hotel management agreement may result in a loss of a loyal customer base. The rationale for keeping a hotel management agreement in place could be as simple as the fact that the hotel manager has been fulfilling its obligations successfully. On the other hand, if a hotel manager has not been living up to the standards set forth in the hotel management agreement, rejecting the hotel management agreement provides an opportunity to place the hotel under new management. In determining whether to keep the hotel management agreement in place, the trustee will look to past performance of both the hotel and the hotel manager to confirm whether keeping the hotel manager is in the estate's best interest. For example, it is important to look to the hotel manager's track record in keeping up with books and records and fulfilling other duties under the hotel management agreement, which will affect the hotel's future profitability.