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In Part 1 of this article, we discussed the framework of hotel agreements, discussing the Hotel Management Agreement (HMA) and other ancillary contracts, and looked at some of the more common payment mechanisms in the HMA.
In Part 2, I will focus on some other aspects of the HMA which can often be heavily negotiated.
A perfectly balanced HMA is in theory a compromised win-win for both the Owner and the Operator; the more success, the more profit for both parties to share. With the hotel business being a service industry, and therefore a people industry, the employees will be critical to the success of the project as a whole.
However employees always bring cost and risk to their employer, for example, costs of health insurance, mandatory tax and welfare contributions, and, of course, litigation risk for personal injury or termination of employment.
It is always a matter for negotiation as to who will be the employer of the hotel’s employees. In certain jurisdictions (particularly in the Middle East), the Owner, by way of local establishment may be better placed to be the de facto employer. A common compromise is that the majority of employees are employed by the Owner, while the Operator directly employs the senior management of the hotel.
Certainly, if the Owner agrees to engage the employees of the hotel then it should take specialist advice as to what other obligations and liabilities it will incur (for example, an end of service payment to employees). Further, the employees often benefit from, but are also bound by, the Operator’s HR policy.
The Owner must consider this policy as part of agreeing the HMA so that it can assess, for example, any additional benefits the employees will be entitled to, and also to ensure that the same are treated as operating expenses.
Another matter worth the Owner’s attention is an anti-poaching clause for when the HMA terminates or expires, which will prohibit the Operator from being able to poach any of the employees (usually for an agreed period of time).
This is likely to be more critical for the senior management team, such as the hotel’s general manager, where experience and expertise (or more appropriately, the loss of it) could have a serious effect on the success of the hotel.
It is rare to find an HMA which contains a provision allowing an Owner to terminate at anytime (ie “without cause” or “for convenience”).
Perhaps the primary reason an Owner would want a provision like this is in case a better opportunity for the asset will present itself.
For example, if market conditions would create a better yield for, say, an office block, and the Owner wishes to convert the premises.
On the occasions where an Operator may agree to these types of provisions, the Operator will usually require a payment from the Owner.
Such a payment was traditionally based on a multiplier of the yearly management fee (eg 2 or 3 times) but we have seen a move towards calculating the payment based on an approximation of the fees that the Operator would have otherwise received during the unexpired term of the HMA.
This can amount to a very substantial payment, particularly if the termination occurs early in the term. If an Owner cannot negotiate a reduced payment, then a termination for convenience right may not be viable.
Rather than a termination for convenience, an Operator may be more amenable to a performance based termination clause, which is triggered by the Operator’s failure of a performance test.
It is common for the performance test to be based on the hotel’s “REVPAR” (ie revenue per available room), with the intention that the test is failed if the actual REVPAR is below the average REVPAR for a particular period for a group of hotels comparable to the hotel in question.
There are a number of other methods which could be used to assess the performance of the hotel and, once again, this is largely down to the negotiation of the parties.
However, careful attention needs to be paid to a performance based termination clause as such clauses can be difficult, if not impossible, to activate.
A number of termination clauses we have seen oblige the Owner to demand a cure payment from the Operator. Assuming such a payment is made, the Owner is not entitled to terminate. This provision is usually referred to as the “do over” provision as it allows the Operator to literally pay for its mistake and avoid termination.
In our view, the Owner either has to ensure that the performance based termination clause has teeth or it is better protected by ensuring that the HMA contains the ability to withhold the payment of management fees where the Operator is under-performing against clear and precise KPI’s.
Another common termination right an Owner may request is a unilateral termination right in the event of a sale of the hotel. Again, the Owner may expect to be liable for a considerable fee to the Operator in consideration of such a termination right.
In our experience a termination right in favour of an Owner in the event of a proposed sale is not usually accepted by an Operator. Instead, an Operator will agree to a permit the sale of a hotel to a new owner provided that the new owner meets minimum qualifying criteria and is not a competitor of the Operator.
There can often be disagreement between an Owner and an Operator as to what is meant by the term ‘competitor’.
It is not uncommon for an HMA to contain a restriction on the Operator from developing and/or entering into any other HMA using the Brand within an agreed restriction zone (sometimes referred to as an ‘Area of Protection’).
In theory this is a sensible provision from the Owner’s perspective (but there are other arguments that competition from the same Operator in the protection zone is in the better interests of the Owner than competition from a third party operator, which is beyond the Owner’s control).
A number of potential issues need to be considered, such as the extent of the restriction zone, the sufficiency of the protection provisions in the contract, and if the protection zone should be defined metrically (eg 4km radius) or geographically (eg in the same city, suburb or area).
Another factor to consider is what type of Operator’s hotel is prohibited in the restriction zone. This will go down to what is meant by the term ‘Brand’.
While branding differences may be apparent between, say, a four star rating and a five star rating, there are some more subtle gaps that may need to be considered.
For example, if the Operator operates a budget hotel brand, will the clause function to prevent the Operator from opening another similar hotel in the restriction zone which branded as “budget-plus” (eg due to one minor additional amenity).
We would always advise upon the name and brand of the hotel being settled upon as part of entering into the HMA and for the restrictive covenant to be as wide as possible in terms of covering other brands which may be similar to, and compete with, the hotel.
When it comes to brand standards, the traditional position was that the Operator would operate and manage the hotel and the Owner would repair and maintain the hotel to the level usually expected of a hotel with the same star rating.
This has grown into an imprecise standard and doesn’t reflect the Operator’s desire to ensure that all its hotels are operated and maintained to the same standard. Consequently, most HMAs now refer to the Operator’s ‘Brand Standards’.
Most international Operators have spent considerable resources compiling a brand standards book which is then referred to in the HMA, and some even resist providing copies to the Owner.
Obviously, it is vitally important for an Owner to consider the brand standards in detail before signing the HMA. More often than not, it is safe to say that the brand standards are exactly what the Owner is paying for.
The challenge, therefore, is to find the balance between, on the one hand, the Operator’s desire to achieve uniformity across all hotels branded the same, and on the other hand, the Owner’s desire for the Operator to manage the hotel reasonably (including prudent management of FF&E and capital expenditure programmes).
An Owner should be heedful of clauses that will oblige it to conform in all respects with the brand standards, as this may result in the Owner incurring significant additional capital contributions.
Over recent years there has been an emergence of brand leverage. This is the desire on the part of the Operators to get more value from their brands than was previously the case. This can be done in many ways.
Branded Residences are developments which consist of a hotel and adjoining residential accommodation. The residences are branded using an Operator’s intellectual property and sold to the public and the Operator receives a proportion of the sale price for making its brand available.
Operators are increasingly introducing Brand Partners into their business models. Some HMAs provide that an Operator may have one or more brand partners during the operating term and allow the Operator to place marketing information relating to such a brand partner in the hotel (and particularly the hotel rooms).
Furthermore, the Owner is generally prohibited from marketing any competitive brands within the hotel.
Generally, the HMA will not provide for a payment to an Owner in return for an Operator’s ability to access the hotel and its amenities in this fashion. Therefore, there is a need to create an environment where both an Owner and an Operator receive a fair return for their respective contributions. If not, it is reasonable to anticipate that there will be increasing resistance to brand leverage.
Not all markets are the same, particularly in the hotel industry, and a requirement that makes perfect sense in one market may not be appropriate in another – this is particularly true of the Middle East. Likewise where labour laws impose stricter requirements on employers, Owners need to pay heed to the higher costs and demands this will place on the budget.
With an increasing trend in legislation with extra-territorial effect, where the Operator is an international business, the Owner may be required to submit to international sanction obligations that may fetter its discretion to do business.
As mentioned in Part 1 of this article, the Owner often approaches the deal from the other side of a distinct knowledge gap, by virtue of the Operator’s industry experience.
The contents of an HMA can present many pitfalls for the unwary Owner (we have heard of Owners unwittingly entering into provisions that shift the entire risk of the business to them alone, irrespective of the Operator’s lack of performance or, indeed, negligence).
When dealing with expert Operators, an Owner will be well advised to engage specialist counsel to assist it to bridge the gap towards a more reasonable bargain.
This article was written by Simon Green.
For more information contact Simon on +974 40 316610 or email@example.com