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.

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Excellent customer service is vitally important in all businesses but it is especially important for hotels where customer service is the lifeblood of the business. Outstanding customer service is essential in creating new customers, retaining existing customers, and cultivating referrals for future customers. Employees who meet and exceed guest expectations are critical to a hotel's success, and it begins with the hiring process. It is imperative for HR personnel to screen for and hire people who inherently possess customer-friendly traits - empathy, warmth and conscientiousness - which allow them to serve guests naturally and authentically. Trait-based hiring means considering more than just a candidate's technical skills and background; it means looking for and selecting employees who naturally desire to take care of people, who derive satisfaction and pleasure from fulfilling guests' needs, and who don't consider customer service to be a chore. Without the presence of these specific traits and attributes, it is difficult for an employee to provide genuine hospitality. Once that kind of employee has been hired, it is necessary to empower them. Some forward-thinking hotels empower their employees to proactively fix customer problems without having to wait for management approval. This employee empowerment—the permission to be creative, and even having the authority to spend money on a customer's behalf - is a resourceful way to resolve guest problems quickly and efficiently. When management places their faith in an employee's good judgment, it inspires a sense of trust and provides a sense of higher purpose beyond a simple paycheck. The April issue of the Hotel Business Review will document what some leading hotels are doing to cultivate and manage guest satisfaction in their operations.