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The hotel industry has seen a huge rise in activity in the Middle East in the last decade. Major international operators have entered the region in force, and have run successful and profitable operations. Most regional jurisdictions, however, have relatively restrictive laws with respect to international investors owning real estate. In addition, most operators are now disposing of their hotel property portfolios. As a consequence, few hotels in the region are owned by the operators. Instead local companies will own and develop the hotel and enter into management agreements with operators.
This article is the first of a two part series which looks at hotel projects in the Middle East, and this article briefly examines the structure of the Hotel Management Agreement (HMA) (the central contract in hotel projects) and the wider suite of ancillary agreements. The second article will address some of the key issues to consider in relation to the provisions of a HMA.
Under the HMA, the owner or developer of the hotel (Owner) appoints an operator (Operator) (often a household name in the hotel industry) to operate the hotel on an exclusive basis. While all HMAs will share a common anatomy, their structure and content can vary widely among Operators.
Being less frequent commercially than, say, loan agreements or construction contracts, HMAs do not come in standard forms, and are individually tailored to reflect the commercial bargain of the parties. Key areas such as fees and termination are often so heavily negotiated that the agreement reached is complex and unique to that particular hotel project.
Due to the size and scale of many operators, and the commercial success their depth of experience will bring to a hotel project, most Operators will require the HMA to be on their standard form agreement. These days most major Operators have developed significant in-house legal capability, relegating the Owners to the other side of a distinct knowledge gap. For these reasons the prospective Owner would be well advised to engage specialist legal counsel.
While the HMA is the main contract, a hotel agreement between an Operator and an Owner can require several other ancillary contracts. If the hotel has yet to be developed, the parties may enter into a Technical Services Agreement, which requires the Operator to provide certain consultancy services to the Owner (for a fee) to ensure that the hotel’s construction meets the Operator’s requirements and specification.
If the Operator offers additional hospitality services (eg a club loyalty programme or centralised booking services) there may be a Central Services Agreement to govern such matters (although if not too complex in nature, these additional services may be dealt with in the body of the HMA). Many major Operators require a separate IP Licence Agreement relating to the use of the Operator’s brand by the Owner.
Finally, where the Owner is seeking finance in relation to the development or acquisition of the hotel, the Operator may require a Non-Disturbance Agreement to ensure its continued operation of the hotel without interference from the financier.
A successful hotel deal should see the Owner achieving profits as a result of the Operator’s experience and expertise in running hotels. In return, the Operator receives a fee, which can be structured to include one or more of a basic management fee, an incentive fee (usually profit based), a licence fee and fees for other mandatory billable services. Owner’s however should be on guard against risk allocation provisions in the HMA which can rapidly erode their margins for such profit.
Prior to each year of the HMA term, the Owner and Operator will agree an operating budget which covers the revenue and expenses for the forthcoming year. There are usually two main accounts; the Operating Account and the FF&E Account (Furniture, Fixtures and Equipment). Hotel revenue goes into the Operating Account to cover operating expenses, and where there is a deficit, may require a “top-up” from the Owner.
The Operator will be entitled to use the Operating Account for the payment of expenses which have been agreed pursuant to the operating budget or otherwise in accordance with the HMA. The Operator will pay a certain amount from the Operating Account into the FF&E Account to cover expenditure on, replacement or substitution of the FF&E during the term. The Owner will be obliged to ensure that there is sufficient monies in the FF&E Account to meet the FF&E requirements pursuant to the operating budget.
The Owner is typically responsible for undertaking any repairs to the hotel of a structural or capital nature. If the Owner fails to undertake such repairs, the Operator may be able to do so from the FF&E Account.
Following the payment of all operating expenses, the contribution to the FF&E Account and the payment of the management fees, the Operator is usually under an obligation to remit to the Owner any remaining funds (if any) held in the Operating Account.
Consequently, the provisions regarding the operating budget and ensuring that the Owner has sufficient control over the Operator (both in relation to its powers as well as in relation to its permitted expenditure) are essential.
Another key provision within a HMA relates to the calculation and payment of the management and related fees. In this regard, there is no one size fits all position. Each HMA will be different and will reflect the commercial agreement of the parties. A current emerging trend is the introduction of enhanced risk/reward alignment (arguably in the Owner’s favour) within the HMA structure.
Previously, the normal fee structure was known as “three plus ten” (where the Operator’s fees were 3% of revenue and 10% of profit). This was not efficient at aligning risk and reward as the Operator could usually make a sufficient return from the revenue based fee so that even if the hotel failed to make a profit, the HMA was still profitable for the Operator.
In our experience, there has been a gradual reduction in the quantum of base fees and a corresponding increase in the level of incentive (ie profit based) fees resulting in closer alignment between both the Owner’s and the Operator’s ultimate remuneration from the bargain.
In Part 2, we will highlight a number of key issues to consider in relation to the main terms within a HMA and examine further some of the points mentioned above.
For more information please contact Simon Green, Partner
T: +974 40 316610