Hotel Management Agreements Today
By Nelson Migdal Shareholder & Co-Chair Hospitality Practice, Greenberg Traurig LLP | February 17, 2011
The credit world is considered by many to be in turmoil. Real estate values as measured through investment sales are below the lofty heights of just months ago. Residential absorption is dismal in many markets. Nevertheless, the possibilities for mixed-use development, anchored by an imagination catching array of amenities, remain strong, both domestically and internationally. In such a climate, the hospitality industry is attracting interest from experienced developers, owners and operators to be sure. However, there are new players in the game who see the allure, but are less familiar with the rules.
This article provides a brief overview, both historic and current, of the law relating to hotel management agreements. The concepts and principles discussed generally apply to the relationship between hotel owners and operators. Certain ancillary and operationally-specific issues (such as termination rights to limitations on the authority of the operator with respect to purchasing goods and services for the hotel) will be only briefly introduced.
Generally, hotel management agreements prior to the early 1990's were 20- to 30-year, non-cancelable contracts that granted the operator (usually the company that controlled the hotel brand) near-total control and authority over all aspects of hotel operations. Such contracts provided little potential for removal of the operator for default or for convenience of the owner. In other words, the hotel management agreements were considered, except in a "technical-legal" sense, obligations that ran with the land. The equivalent of a "no cut" contract. This is a throwback to an earlier time when the relationship between owners and operators of hotels was more frequently structured as a lease, rather than as an agreement similar to an agency. Eventually, the hotel management industry shifted to the use of the agency agreement structure because this form presented banks and other sources of financing with an easy way to value the hotel operating company. The calculation was easy - simply project the cash flow from management fees over the term of the agreement.
A string of court decisions and jury verdicts have helped to change both the legal and business relationship between hotel owners and operators. As a result of such decisions and jury verdicts, the following observations generally summarize the current state of the primary principles that drive the negotiation process of hotel management agreements and the relationships created thereby:
- When is the operator acting as the agent of the owner and when do the legal principles of agency apply?
- When is the operator a fiduciary of the owner?
- Disclosure is king.
- Which party is the employer and why?
- When can the agreement be terminated?
- Who indemnifies whom for what? Of course the above does not encompass a complete description of the issues applicable to these agreements.
In 1991, a court determined that the owner of a hotel could terminate the agency between the owner and the operator without cause and regardless of the stated term of the management agreement, subject to liability for damages for wrongful termination, unless the operator had an economic interest in the hotel. In 1993, a court in the same state as the first court came to the same conclusion, but added that even if the operator had made a loan to the owner through a related, but legally separate entity from the operator, that would not constitute an economic interest sufficient to make the agency irrevocable.