The Performance Test: Time for a Change?

By Paul Courtnell Director, Leisure & Resorts Group, Gunster LLP | November 07, 2010

Introduction

Most hotel management agreements contain a "performance test" that gives the Owner of the hotel an option to terminate the management agreement if the Operator fails to achieve one or more financial benchmarks in the operation of the hotel. Many of these performance tests were negotiated under very different economic conditions than prevail today. Given the new reality that prevails in the hotel industry, Owners, Asset Managers and Operators should be reviewing the performance tests in their existing management agreements to determine if it is time for renegotiation. With respect to new management agreements, the parties should approach the performance test by keeping in mind the mistakes made and lessons learned from the past. This article explains the components of a typical performance test in a management agreement and recommends areas for examination and negotiation.

Components of a Typical Performance Test

A typical performance test negotiated in better economic times probably contains the following elements –

  • Delayed Start Date: Typically, the performance test may not commence until the fourth or fifth full year of management by the Operator. Particularly in the case of a newly constructed hotel, the purpose of the delayed start date was to allow the hotel to reach stabilization.

  • More Than One Year of Failure: The language usually provides that the test must be failed either for two consecutive years or two out of three years for the Owner's termination option to be activated.

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