Designer Hotels Are In: But Take Care to Avoid a Major Faux Pas
By Theodore C. Max Partner, Sheppard, Mullin, Richter & Hampton LLP | May 06, 2010
In 1990, the Italian designer, "Krizia" Mariuccia Mandelli, known for Krizia and Krizia Uomo lines, opened the Krizia K Club on the Antiguan Island of Barbuda in the West Indies. Since that time, a parade of designers have given permission for the use of their labels in the hospitality industry: Diesel (South Beach, Miami), Versace (Palazzo Versace in Queensland, Australia and Versace Palazzo in Dubai, United Arab Emigrates), Ferragamo (Lungarno Hotels in Florence, Italy), Armani (Dubai and Milan in 2008), Bulgari (Milan and Bali) Ralph Lauren (the Round Hill Hotel and Villas Resort in Jamaica), Anouska Hempel (The Hempel (London) and Blakes Hotels in Amsterdam and London); Antonio Miro (Hotel in Bilbao, Spain), Todd Oldham (The Hotel in Miami, Florida); and John Rocha (The Morrison Hotel in Dublin, Ireland). Each of these luxury hotels involves a great deal of foresight and planning in locations around the world.
The move by international fashion labels into the hospitality industry is a logical extension of the strong brand awareness accorded high profile designers and their fashion brands. Fashion designers can greatly enhance a property by lending the cachet and prestige of their brand name as well as through their design talents. The hotel experience gives the designer a perfect platform for advertising and marketing the lifestyle and high luxury that are represented by their brands. Numerous consumers visiting designer hotels or frequenting the five star facilities are permitted to experience and spread the word and image of lifestyle of the designer's brand. or example, the Palazzo Versace with its gold lion heads, roman columns and vibrant prints celebrates all that is Versace.
But care must be taken to avoid potential liability that may arise from the application of fundamental agency principals to the hotel management agreement. Recently, a jury in Maryland in the United States District Court for the District of Maryland found for the owner and held that Ritz Carlton (and Marriot International) had breached in hotel management agreement and its fiduciary duty by building a new Bulgari-branded hotel only seven kilometers from the Ritz Carlton Bali Resort & Spa under which Ritz Carlton served as an agent. The jury awarded $382,304 in compensatory damages and $10 million in punitive damages, plus attorney's fees.(1)
The Bulgari decision is a serious reminder that, while the hotel management agreement is the cornerstone of the business relationship, including setting forth the parameters for the branding, the guest perception, financing, ownership structure and day-to-day operations, courts will apply common law agency principles, which may, contrary to the language in the agreement, impose fiduciary obligations or to provide for termination of a hotel management agreement if it can be shown that the operating firm has breached the management agreement or its fiduciary duty to the owner. This is not the first result of this type. In fact, there has been a long line of cases which involved similar findings.
For example, recently in 2660 Woodley Road Joint Venture v. ITT Sheraton Corp., a jury in the United States for the District of Delaware awarded almost $15 million in actual damages and over $37.5 million in punitive damages against ITT Sheraton Corp. based upon its alleged breach of its management agreement and fiduciary duties and claims asserted relating to its use of a Sheraton purchasing program and failure to pass volume discounts on to the owner. While the damages awards were reduced on appeal and the Third Circuit Court of Appeals held that the evidence did not support an award for breach of agency provision of the management agreement, the Third Circuit nevertheless upheld the termination of the management agreement, notwithstanding the fact that the management agreement had "no cut" provisions. In Woodley, the district court held that the owner had the power to terminate the agency relationship, especially where the evidence demonstrated that the operator had received "kickbacks" and "commercial bribes" from its vendors but had not shared these benefits with the owner. The Third Circuit Court of Appeals affirmed in part and remanded the case and vacated the $10,260,000 award for breach of contract, affirmed the award for breach of fiduciary duty and reduced punitive damages to $2,025,000.
Any breach of a fiduciary duty by the hotel operator might lead to a similar result. This is significant because licensors or franchisors in the hotel industry may no longer rely solely on a contractual provision to deny that an agency relationship exists or to state that the management agreement may not be terminated. The only exception to this general rule is where the "power is given as a security" or "[a] power is coupled with an interest" for the benefit of the managing party. See Government Guarantee Fund of the Republic of Finland v. Hyatt Corp., 95 F. 3d 291 (3d Cir. 1996); Pacific Landmark Hotel, Ltd. v. Marriott Hotels, Inc., 19 Cal.App.4th 615, 624-25 (Court of Appeal, 4th Dist. 1993). A principal may grant an irrevocable agency power for the purpose either of furnishing a security to protect a debt or other duty, or facilitating the performance, effectuating the objects, or securing the benefits of a contract. Restatement (Second) of Agency (1950) SS 138 cmt. c)). Essentially, an agent must have some owned interest in the hotel for a management contract's provision stating that the agency is irrevocable to be effective. The existence of a franchise with a brand name has been held to be not enough because franchise agreements are generally severable and independent from the management contracts and different hotels may be managed by others. See, e.g., Woolley v. Embassy Suites, Inc., 227 Cal.App.3d 1520, 1533 (Court of Appeal, 1st Dist. 1991).