Mr. Brewer III

Hospitality Law

A Fight for the Flag: Battling Competition From Disloyal Hotel Operators

By William A. Brewer III, Co-Founding & Co-Managing Partner, Bickel & Brewer

In the evolving legal landscape between hotel operators and owners, the operator's primary goals remain the same to maximize brand recognition and revenue. These goals, however, are often in conflict with an owner's focus on his hotel's bottom line. As a result, owners should protect themselves from operators that all too frequently seek to compete against the very hotels from which they are reaping significant management fees. One way that owners can do so is by pressing the duty of loyalty that operators owe them as managers of their hotel -a duty which prevents the manager from competing with them.

A. The First Line of Defense: The Management Company's Common Law Duty Of Loyalty Bars It From Competing With The Owner

Woolley v. Embassy Suites, Inc. is often referred to as the seminal case in defining the relationship between a hotel owner and hotel manager as one of agency. In Woolley this event correctly defined an agent as "'anyone who undertakes to transact some business or manage some affair, for another, by authority of and on account of the latter, and to render an account of such transactions.'" Since then, courts have routinely held that the hotel owner-manager relationship is per se one of principal-agent. That relationship, in turn, imposes a number of duties - often described as default fiduciary duties - on hotel management companies which ensure that they fulfill their obligations under the operating agreement in a manner that gives priority to the hotel owner's best interests. Chief among these obligations is the common law duty of loyalty.

1. The Operator-Agent Cannot Compete With the Owner-Principal

The duty of loyalty requires that, unless specifically agreed otherwise, an agent must act solely for the benefit of its principal in all matters relating to the agency. This means that the agent may only act in accordance with the principal's consent - whether that consent is manifested in the contract between the parties or by separate, express approval after full disclosure. The duty of loyalty thus forbids a hotel management company from acting on its own behalf, as the agent of another in a matter in which the two principals' interests conflict, or otherwise engaging in self-dealing with respect to the subject matter of its operating agreement with the owner, without the owner's knowledge and express consent.

Of particular importance is that an agent cannot compete with its principal regarding the subject of the agency. In other words, the hotel operator may neither act as a competitor, nor agree to act on behalf of others who themselves are in competition against the hotel owner, without the owner's consent. Moreover, an agent is obligated to disclose to its principal all information material to the subject matter of the agency. That is particularly true where the agent deals with the principal on its own account. Thus, the failure by an agent to disclose even potential competitive activity is a breach of fiduciary duty, and may constitute fraud. Under these principles, a management company's failure to disclose relevant financial information to the owner may result in the right of the owner to terminate the operating agreement.

2. The Operator-Agent Must Account to the Owner-Principal for Anything It Receives of Value

Similarly, the manager has a duty to account to the owner for the money and other property the manager has received or paid out on behalf of the owner. Such accountings should be initiated by the operator when they concern matters and transactions of which the owner is unaware. Unless otherwise agreed, a manager that receives anything of value in connection with transactions conducted on behalf of the owner is under a duty to give those benefits to the owner.

3. The Operator-Agent Cannot Use Confidential Information of the Owner-Principal For Its Own Benefit

Finally, unless otherwise agreed, the duty of loyalty imposes on the agent an obligation not to use the confidential information of its principal for the agent's own benefit or to the disadvantage of, or in competition with, the principal. That rule applies to sensitive or proprietary information, such as a hotel's customer lists and operating and financial data. Above all, the manager has a duty to account for any usages of the owner's confidential data.

B. The Second Line of Defense: Preserving The Manager's Duty Of Loyalty In The Operating Agreement

For the hotel owner, an operating agreement that protects the owner from limitations on the manager's duty of loyalty is an effective means of ensuring that the management company's efforts to maximize the owner's interests. With that in mind, it behooves owners to recognize efforts by the operator to disclaim that duty, and to consider the implications of such disclaimers. In the current market, this goal may require tenacity. Management companies may attempt to have the owner waive or dilute their common law fiduciary duty of loyalty to the hotel owner in a number of different ways.

1. Waivers of Fiduciary Duty - Must Be Specific to Be Enforceable

The most obvious language in the operating agreement that purports to limit any fiduciary duties owed to the hotel owner is language of waiver. Agency relationships, such as those between hotel owner and manager, are typically contractual in nature. Accordingly, the parties are free in their written operating agreement to eliminate the default fiduciary duties owed by the manger to the owner, including a duty not to compete. However, an operating agreement cannot "write out" fiduciary duties by simply denying that an agency relationship exists between the parties. In order for a disclaimer to be effective, it must specifically and clearly state that the manager owes no duties to the hotel owner apart from those enumerated in the contract.

Owners faced with such language in draft or proposed operating agreements should carefully consider the implications it will have on their relationship with the management company. The duties the manager will owe to the owner will be limited to those detailed elsewhere in the agreement. This means that a hotel owner that accepts an operator's waiver of fiduciary obligations must anticipate all potential areas of conflict between his profit motive and that of the manager. The owner must then include in the operating agreement explicit provisions restricting the manager's freedom to act against the owner's best interests in those areas.

2. Even Express Disclaimers of Agency May Be Unenforceable

Owners who have accepted such disclaimers in their current operating agreements may not eliminated the existence of an agency or fiduciary relationship between themselves and their management company. It is well-settled law that it is not the label the parties give their contractual relationship that determines if an agency relationship is created, but rather the circumstances of the particular situation, or the actual conduct of the parties in carrying out the contract. Thus, even where an operating agreement disclaims that any agency exists, if the resulting relationship between owner and operator manifests itself in a way in which an agency relationship would normally attach, then an agency exists even if the parties did not intend to create one.

3. Other Ways Managers Attempt to Dilute their Duty of Loyalty Via the Operating Agreement

Owners should be aware of other, less obvious, ways in which operators may attempt to limit their duty of loyalty. For example, specific language in a proposed management agreement may supplant the operator's duty of loyalty by providing that it can contract for goods and services from its own affiliates, that related party transactions are permitted to exceed the costs of providing goods and services, or that such transactions can be greater than an arm's length market price. Absent the hotel owner's prior express agreement to such acts, all of them violate the operator's duty of loyalty.

The proposed operating agreement may characterize the relationship between manager and owner as something other than principal and agent. For example, it may define the operator as an "independent contractor" rather than an agent. For the reasons stated above, a court should not permit an operator to evade its common law fiduciary obligations merely on the basis of a label in the operating agreement. Nevertheless, an operating agreement containing such a designation invites conflict over the issue.

C. Going On The Offensive: Battling the Disloyal Operator

By ensuring that their operating agreement has left the manager's duty of loyalty to them intact, hotel owners that find themselves in the unfortunate position of combating disloyal competing operators will have, at a minimum, the following weapons for recourse:

1. Claims for breach of fiduciary duties.

Given the broad scope of the operator's duty of loyalty - in other words, to act always in the owner's best interests - such a claim arises not only where an operator engages in direct competition by actually operating another hotel in the same market or territory as the owner, but also when it competes in other ways.

2. Claims for injunctive relief.

Owner-principals can seek to obtain an injunction preventing the disloyal and competitive behavior being engaged in by their operators-agents.

3. Claims for breach of contract.

Owners can also sue to enforce specifically negotiated contractual provisions, such as those guaranteeing a rate of return for the owner, that mandate the operator fully disclose all information relevant to evaluating its performance under the operating agreement, or that impose restrictions on the operator from opening a competing hotel in a certain geographical area. However, in most United States jurisdictions, if an owner has the option to pursue both a tort (e.g. breach of fiduciary duty) and contract claim, it has must choose a remedy in either cause of action. It cannot elect a remedy in both.

Conclusion

The operator's common law duty of loyalty to the hotel owner is a significant weapon to ensure against unauthorized competition from the operator. Accordingly, the owner should remain aware of the scope of that duty, be wary of attempts by the operator to disclaim or dilute it in the operating agreement, and seek appropriate counsel as it considers the implications of contracts that appear to do so. Armed with such knowledge, an owner may well decide it would be preferable not to rely solely on general fiduciary and agency principles to govern its relationship with the management company, but to also to work out the possible pitfalls of the relationship within the operating agreement before finalizing the deal. Whatever that decision, the avoidance of costly litigation becomes more likely where the owner has a clear understanding of its rights, and the operator's obligations, under the management agreement.

William A. Brewer III is co-founding and co-managing partner of Bickel & Brewer, with offices in Dallas and New York. Under Mr. Brewer's direction, Bickel & Brewer has become renowned for its innovative handling of disputes within the hospitality industry. For the past decade, Bickel & Brewer has represented hotel franchisors, management companies, owners, developers and investors in the highest profile litigation in the hospitality industry. He is a member of various philanthropic organizations, including the New York City Partnership and the Board of Trustees of Albany Law School. Mr. Brewer III can be contacted at 214-653-4811 or wab@bickelbrewer.com Extended Bio...

HotelExecutive.com retains the copyright to the articles published in the Hotel Business Review. Articles cannot be republished without prior written consent by HotelExecutive.com.

Receive our daily newsletter with the latest breaking news and hotel management best practices.
Hotel Business Review on Facebook
RESOURCE CENTER - SEARCH ARCHIVES
General Search:

APRIL: Cultivating Guest Satisfaction and Retention

Simon Hudson

According to the Oxford Dictionary an apostle is a “vigorous and pioneering advocate or supporter of a particular policy, idea, or cause”. For hotels, creating apostles should be a priority. They are the most loyal customers and they are so satisfied that they want to convert others to share their experiences. But how do hotels create apostles? This article looks at how some hotels around the world are delivering not only superior products and services, but through customization and personalization are creating guests who would not dream of staying anywhere else. READ MORE

Edward Reagoso

In the hustle and bustle of being accountable for so many facets of the hotel business, a hotel general manager needs to do one thing to truly secure his or her future in our industry, that being “insuring your team members truly care about your guests stay.” Sounds simple enough, right? This is not rocket science and I mean no disrespect to anyone struggling with operations or sales issues that can often seem surmountable. We all have these problems at one time or another. There are resolutions to every issue we have. The resolution to any problem is really just a matter of applying a specific strategy that will minimize the issue or frankly, make it go away completely. How many times have you walked into a situation with a guest that was surprised and upset that a tiny issue was never dealt with by a front desk agent, housekeeper, waiter, maintenance person, or even a manager that worked for you? I have too, the important thing is that we learn from this and move forward. One must insure everyone on our team grasps the importance of caring and the application of certain techniques can solidify a culture. Getting everyone on your team to care about your guests really is the key. READ MORE

Rick Garlick Ph.D.

A primary objective of hotel operators is to keep their properties full of ‘heads in beds’ to capacity. While this goal is understandable, there is a risk hotels may market themselves indiscriminately and draw guests that are not a good match to their particular value proposition. While this meets a short term goal of wasting as little inventory as possible, there is a longer term risk that these guests may provide negative feedback about their stays, even though the hotel was being true to its own identity and branding. Indeed, the guest experience cannot be fairly evaluated apart from the expectations and preferences a person brings to the hotel from the time he or she books a room. Using a comparative restaurant example, a top steakhouse could never deliver a satisfying experience to a committed vegetarian, even if it provided the best cut of meat and the most attentive service. You have to like steak to positively evaluate the experience. READ MORE

Aaron  Housman

Things will go wrong. It’s inevitable in life and in business. And the sooner one gets to that conclusion the sooner he can get on with what comes next: preparing for the inevitable. In the hotel business that means following up with guests when the experience is substandard for any number of reasons, from guest service to property maintenance to the type of sheets on the bed. But there is a difference between just preparing for the inevitable and being well-prepared. Following up effectively with upset guests doesn’t happen accidentally. It is planned, trained tracked and executed every day. It is a way of life for best-in-class operations. READ MORE

Coming Up In The May Online Hotel Business Review


Feature Focus
Hotel Sustainable Development: Integrating Practices for the Environment and the Bottom Line
The term “sustainable development” was first coined in 1987. In a report entitled, “Our Common Future,” the Brundtland Commission defined sustainable development as follows: “Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” This definition immediately caught on. In the business world, it is sometimes referred to as a triple bottom line – capturing the concept that investments are profitable, good for people and protective of the environment. Within the hotel industry, companies have taken an active role in committing themselves to addressing climate change and sustainability. Hotel operations have realized that environmentally sound practices not only help the environment, but can lead to cost reductions, business expansion, and profit growth as consumers increasingly seek environmentally sustainable products and services. In a recent survey by Deloitte, it was noted that 95% of respondents believe that the hotel industry should be undertaking “green” initiatives. Additionally, 38% of respondents said they made efforts to identify “green” hotels before traveling, and 40% said they would be willing to pay a premium for the privilege. These results suggest that consumers want and expect sustainability in their travel plans. In response to these trends, many hotel companies and on-line travel agencies have even begun offering their consumers an opportunity to purchase carbon offsets to reduce the environmental impact of their trips. The May issue of the Hotel Business Review will document how some leading hotels are integrating sustainability practices into their hotels and how their operations, consumers and the environment are profiting from them.