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

By William A. Brewer III Managing Partner, Bickel & Brewer | January 14, 2010

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.

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