Management Agreement Termination

By Nelson Migdal Shareholder & Co-Chair Hospitality Practice, Greenberg Traurig LLP | December 10, 2017

Co-authored by Nicholas N. Palmer, Associate, Greenberg Traurig

Don't do it! At least not without some serious thought to be sure there is simply no other way to go. With some very high profile cases of a hotel owner removing the hotel manager founded on common law principles of agency that give a hotel owner the power to revoke the agency, hotel owners and hotel managers might be tempted to rely on agency law as a "Plan B" if the owner-manager relationship sours despite what is in the hotel management agreement. Consider that this might not be the best laid plan as between an owner and manager.

In fact, a negotiated exit between the parties is often a better strategy than a unilateral termination by a hotel owner. Remarkably, the cases on the subject have actually been very consistent since the earliest cases about 30 years ago.

So how did we get here? The principal-agent relationship is grounded in English common law, and has always been an aspect of the owner-manager relationship. In very general terms, an agency is a fiduciary relationship between a principal and an agent where the agent acts on behalf of and for the benefit of the principal and is theoretically subject to the control of the principal. It is the theory that the hotel manager is acting in place of the hotel owner and subject to the hotel owner's control that leads a hotel owner to be legally responsible for the acts of the manager undertaken within the scope of the agency. This notion of control in the agency relationship is interesting in the context of hotel management agreements because those agreements often grant the manager wide discretion in the management and operation of the hotel while significantly limiting owner's approval rights over certain actions.

Bear in mind that when the owner-manager relationship is being examined by a mediator, arbitrator or judge, the characterization of the relationship as an agency relationship is not dependent on how the parties characterize their relationship, or on the form of the agreement, but on the substance of the relationship and whether it meets the basic agency requirements. Moreover, and this is the essential component of the agency relationship, the principal ( i.e., the hotel owner ) always retains the power to terminate the agency, unless the agency is coupled with an interest, which we will discuss below. The hotel owner entrusts day to day management of the hotel to a third­ party that is not an owner of the hotel. Putting aside unique market driven and negotiated provisions such as sliver equity or key money, the hotel manager, be it branded or unbranded, large or small, does not own the hotel asset that it is managing.

This unique relationship, no matter what it may be called in the management agreement itself, will more often than not be characterized as an agency relationship, or as some jurisdictions conceptualize it right now, a contract for personal services. This means that the hotel owner, as the principal, always has the power to terminate the relationship and tell the hotel manager, as the agent, to get out of the hotel. In addition, as a contract for personal services, it is not enforceable by injunction, so the hotel manager/agent is obligated to turn the Hotel over to the owner. Because the principal has the power to terminate the agency, but not necessarily the right, the agent has the right to proceed against the owner of the hotel and demand money damages but it cannot remain in possession of the hotel. Depending upon the term of the hotel management agreement, among many other factors, that demand for damages can be a very significant amount of money.

Remember the comment at the beginning of this article. It may be a very hollow victory for an owner to remove the manager if the manager's potential damages are high. Consider the 15, 20 or 30 year branded agreements where the net present value of lost fees over the term can be a big number. As noted, this may not be the best "Plan B".

To better complete the conversation, let's add the concept mentioned above of agency coupled with an interest. The general agency concept is that the hotel owner, as the principal, always retains the power to terminate the agency, even if doing so constitutes a breach of the agreement. The exception to the rule is that if the agency is "coupled with an interest" in the subject matter of the agency ( i.e., an ownership interest held by the manager in the hotel itself ), the principal cannot revoke the agency. An agency coupled with an interest is also referred to, and can be remembered as, a "power given as security." It is an agency power that is given to the agent to protect a vested interest possessed by the agent in the subject matter of the agency.

In the context of the hospitality industry, it means the hotel. Some hotel managers continue to aggressively pursue the agency coupled with an interest characterization because it renders the agency irrevocable, which means it renders the management agreement not subject to termination other than as expressly set forth in the agreement ( e.g. for a default or failure of a performance test ). An agency coupled with an interest, which would require an investment in the hotel, in the hotel management world is created for the benefit of the manager to protect the manager's interest in the hotel.

Over the decades when an owner has asserted agency principals to terminate the manager, the manager has responded with an argument that there is an agency coupled with an interest, so the principal cannot revoke the agency. Unfortunately, no court has told us what an agency coupled with an interest is in the context of hotel management, only what it isn't. The best guidance we can offer is that in order for an agency to be coupled with an interest, it must be created for the benefit of the manager to protect the manager's direct investment in the hotel or to secure the owner's performance to the manager, independent of the agency relationship. This means that, the manager, as agent, must have a specific, present, and coexisting beneficial interest in the hotel, as the subject matter of the agency.

Monetary consideration, such as the hotel management fees paid to the manager, are not sufficient to establish an interest. Although completely inconsistent with most, but not all, hotel management transactions today, a hotel manager could establish an agency coupled with an interest by being part of hotel ownership with an investment that is material enough to support the argument that apart from the fees the manager can earn under the management agreement, it possesses rights in and to the hotel by virtue of being an owner of the hotel. We have certainly seen this and worked to properly document it in both the joint venture agreement and the management agreement in an appropriate transaction.

Now let's also discuss the nature of the hotel management agreement in the world we live in and work in today. Hotel management agreements are complex instruments that involve the interplay of a diverse set of assets and liabilities, and are frequently executed for extended periods of time. For the most part, hotel management is a professional function that requires a deep bench and a broad array of skill sets not only in operations, but in labor and employment, social media, entertainment, procurement, liquor licensing, revenue management and much more.

Regardless of size or branding, this is a professional business whereby managers can earn recurring monthly management and other fees for their services and not a return on invested capital in the hotel, unless there is a true agency coupled with an interest which, as discussed already, is possible, but infrequent. If the value of the management company is predicated upon recurring monthly fees, then the management company cannot have short agreements or agreements that an owner can terminate at will. Certainly termination and similar provisions can be negotiated into agreements for an owner, but the facts and circumstances of the transaction and the relationship of the parties have to justify such provisions. The more likely scenario is that the owner will have very limited and specific rights to terminate the manager based upon uncured events of default or failure of a carefully crafted performance test.

The reality for a hotel management company is that its value is derivative of the value of its management agreements, so such agreements simply have to be of some significant definitive term and [very hard] for an owner to terminate. Think of it this way; if you wanted to invest in a publicly traded hotel management company how would you react to that investment if all of the management contracts could be terminated anytime the owner wanted? You certainly might still invest in that business model, and it is a business model that is very appealing to owners, but you might sleep better at night knowing that most, if not all of the agreements, were long term and tough to terminate.

So what do we learn from this about management agreement termination today? The first thing to remember is that the hotel management agreement is very different from other commercial agreements. Concepts and thought processes that might apply to Class A office buildings or retail leases do not translate well into the hospitality industry. Completely different skill sets are required. The next thing to remember is that the owner-manager relationship is more like a marriage and not at all like a lease. The agreement itself should be crafted to offer opportunities for dialogue and consultation between the parties and an understanding that it is very unlikely that everything will be wonderful during the entire term so the parties have to anticipate and plan for how to work through the challenges that may arise as a result of macroeconomic or so-called "Black Swan" events that impact the entire economy as well as the purely local issues and calamities that occur at an operating business that never closes.

Whether you are an owner or a manager or a professional that provides advice and services to either or both owners and managers from time to time, the better "Plan B" will be within the agreement itself and through the development of a construct that readily allows for ( and, in fact, requires ) owner and manager communication and cooperation. At the end of the day, it is more likely than not that the cost of termination and litigation will be significantly higher than a negotiated exit strategy.

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This article was co-authored by Nicholas N. Palmer. Mr. Palmer focuses his practice on commercial real estate and hospitality matters. He represents clients in connection with the acquisition, disposition, financing, development and leasing of office, retail and mixed use buildings. Mr. Palmer also represents clients in connection with the acquisition, disposition, management, franchising, licensing and branding of hotels and resorts. He prepares and negotiates various real estate agreements, including purchase and sale agreements, leases, hotel management agreements and numerous other documents in connection with the acquisition, disposition, financing, development, management and leasing of real property. He received his J.D. from The University of Florida Levin College of Law.

Mr. MigdalNelson F. Migdal, is a shareholder and Co-Chair of the firm's Hospitality Practice. He focuses his practice on hotel acquisitions, operations, development and finance, large mixed-use projects, hotel management agreements, licensing agreements, commercial real estate acquisition and sale, and commercial leasing. He has prepared and reviewed management and franchise agreements, purchase and sale agreements, multiple building covenants, and other documents related to the acquisition, financing, development, leasing, management and disposition of hotels, resorts and other real and personal property.Mr. Migdal is a Member of the Adjunct Faculty of the Washington College of Law of American University where he teaches Hotel Law. Mr. Migdal can be contacted at 202-331-3180 or migdaln@gtlaw.comExtended Bio...

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