What is a Hotel Management Agreement?
A hotel management agreement ("HMA") is a contract between a property owner (referred to as the "owner" or "developer") and an operator (typically referred to as a "manager") whereby the manager agrees to manage the asset in consideration for a set fee or a share of the revenue generated by the managed property. HMAs are an important piece of the hospitality industry and are the result of many months of negotiations between the owner and the manager and their respective accountants, lawyers and other experts. Often times these negotiations will take place in the context of a broader development and financing negotiation, and will follow on the heels of the purchaser making a decision to enter into an asset class that they may know little to nothing about. Often the HMA is only one of numerous contractual arrangements that the owner will enter into in order to complete the development of an asset, and it is the developer’s principal document in relation to the ongoing operation of the asset.
The management and promotion of hotels, motels and related facilities has been established as a multi-billion dollar global industry. Most major hotel and resort chains operate on a franchise model wherein they grant a license to one person or company to operate a hotel under the chain’s brand or name in exchange for fees and/or royalties. However, an alternative to the franchise model has emerged in recent decades in which a person or company will develop or purchase a property and then engage a third party operator to run the business and manage the asset. A management company is typically a large, geographically affiliated, organization which will manage a number of properties, often on a global scale. Examples of the more recognizable hotel management companies that may be associated with an HMA or similar document include: Starwood Hotels & Resorts Worldwide, Inc., Hilton Worldwide, Four Seasons Hotels and Resorts, Hyatt Corporation, Accor Hotels, Carlson Hotel Company, Intercontinental Hotels Group, Choice Hotels International, Destination Hotels & Resorts, and The Ritz-Carlton Hotel Company .
An association between a manager and the property owner is governed by greatly varying structures and contractual arrangements. HMAs typically vary from one to excess of 50 years in length, and will usually encompass a physical asset that is just beginning to be realized at the time the agreement is entered into. On occasion, HMAs will include multiple properties either through the aggregation of similar assets in a single agreement, or in the case of a master agreement, whereby a number of properties are managed and/or operated by the same manager pursuant to a common agreement. Regardless of the type of agreement or the length of the term, HMAs are intended to provide assurance to the owner that the property will be operated and managed in accordance with the owner’s quality standards in order to provide a return or value to the owner.
A well organized and drafted HMA will envision and incorporate flexibility into the operation and management of the property in order to allow the parties to essentially customize a framework that is unique to their individual needs and circumstances. The common objective of these arrangements is to ensure that the manager’s services meet the owner’s expectations and that their goals, as set out in the HMA, are achieved in a timely and efficient manner. In doing so, parties must keep in mind and understand the implications of a number of important legal and business considerations such as the resolution of disputes; how liabilities and costs are delegated and apportioned; and indemnity provisions that are put in place to protect the parties from adverse consequences arising from negligence or active fault in relation to the performance of services or failure to act. By clearly articulating and addressing these considerations in a well-structured HMA, the parties are able to allocate the risks and liabilities associated with the operation of the business.
Integral Components of a Hotel Management Agreement
How followed are the MSA 4 generic set of terms?
What are the critical clauses and terms found in hotel management agreements?
The MSAs tend to vary but do seem to follow certain systems and requirements.
The MSAs tend to have comparable terms and conditions governing:
• duties of the parties
• duration of the agreement
• revenue management
• terminations conditions
Duties of the Parties
The Owners duties to the Property are:
• to appoint the Manager to manage the Property and supervise the employment of such employees, contractors, agents and representatives for the Coordinated Operations as are necessary and appropriate, as determined by the Manager;
• to monitor the ongoing operation of the Property;
• to provide, among other things, a non-consolidated balance sheet and income statement for the preceding two fiscal years, the current (to the date of the MSA) budget, a commitment letter or other evidence satisfactory to the Manager of the availability of such amount and on such terms as are satisfactory to the Manager to fund or finance the acquisition, construction, expansion or improvement of the Property, if the Owner is developing or constructing the Property, and such financial statements as of the date of the MSA have been audited by an independent certified public accountant; and
• to execute the MSA and such other documents as the Manager may reasonably request to evidence the Property’s due execution of the MSA.
The Managers duties to the Property are:
• to manage the Coordinated Operations in a manner such that the standards and operation of the Coordinated Operations are consistent with those of the similar properties in the Affiliated Group in the manner deemed reasonable by the Manager and the Owner;
• to provide whatever quality of service the Manager deems appropriate, as its discretion; and
• to adopt the Authority and Procedures, including Designation of the Coordinated Operations Manager and establishing reasonable procedures for access to the Property by Owners, among others.
Duration of the Agreement
Duration of MSAs typically are 1 year to 99 years; with 60 years being the most prevalent. In some cases MSAs are not prone to early termination. At the very least there is a 90-day advance written notice requirement.
A manufactured controversy: Do Owners later use the MSA’s renewal term (with far shorter notice requirements for non-renewal) has the term expired? If Owners intention was to maintain the MSA through the required notice period; its use should be considered the operative term and all payment cathartic terms must be met.
Revenue Management
Typically MSAs require Owners to delegate revenue management to the Manager. Full control of the Owner’s Revenue Management Structure by the Manager, includes component planning, analysis, measurement, reporting and other revenue management services in the best interests of the Property and consistent with the Revenue Standards, as prescribed by the Manager.
Conditions to Termination of the Agreement
MSAs typically provide that the Owner may not terminate the MSA without cause until the MSA has been in effect for [insert number of months], with a similar requirement for the Manager.
Responsibilities and Duties of Parties Involved
Inline with how a franchise agreement (or any other commercial agreement) is formed, the formation of a management agreement involves two parties, the owner and the management company ("Management"). The owner who contributes the capital into the project and as such bearing the risk and reaping the rewards acts as a principal, whilst Management acts as an agent who the owner has engaged to act on its behalf. As an agent of the owner, Management determines how the hotel will be operated in accordance with with the owner’s brand standards, protocols, rules and procedures. On the other hand, the owner will either directly or through another entity also engage a technical services consultant to oversee the practical execution of the development and set out the detailed standards for the operation of the hotel.
Subject to the terms of the management agreement, the owner shall:
a) at its sole cost and expense be responsible for the design, development and construction of the hotel including, without limitation, the provision of funds for the payment of the cost of developing, operating, completing, repairing, furnishing, equipping, maintaining, refurbishing, renovating, rebuilding, replacing, disposing of, dealing with and providing ( i) any and all additional furniture, furnishing, fixtures, equipment and other personal property to be located or used at or in the Property, (ii) any and all additional improvements to be made in or to the fee interest in the Property or the Real Property Interest and (iii) all additional landscaping, signs, sidewalks, curbs and pavements, and (b) reasonably consult and communicate with Management with respect to the details of the design, development, construction, renovation, improvement and expansion of the hotel.
Subject to the terms of the management agreement, Management shall:
a) recommend to the owner the plans and specifications for the development of the hotel including, without limitation, the number of guest rooms, the number of food and beverage outlets, other amenities and public space that are to be developed and constructed;
b) prepare and submit to the owner annual budgets ("Annual Business Plan") and monthly forecasts of the hotel’s projected income and expense that shall include an operating and marketing budget and provide for a variety of plans and operating policies and procedures which shall be developed or recommended by Management as necessary to insure the successful operation of the hotel;
c) employ all lead managers and other employees, both executive and non-executive, as it may reasonably deem necessary or advisable to operate and manage the hotel in accordance with the management agreement and the owner’s policies and to provide the services and facilities to guests of the hotel and the owner;
d) provide to the owner the services of an executive committee having experience relating specifically to the owner’s brand or such other experience as the owner may reasonably request to carry out and perform the obligations and responsibilities of Management under the management agreement;
e) except as otherwise provided in the management agreement, without the owner’s prior consent, incur no individual item of capital expenditures in excess of an amount specified in the management agreement in any fiscal year or in the Annual Business Plan without the owner’s prior written approval;
Money Matters in Hotel Management Agreements
A well-structured hotel management agreement must take financial elements into consideration, including the level and type of management fee for the services provided by the manager (the "Management Fee"), performance requirements and metrics, and how profits will be shared.
3.6.1 What is the appropriate Management Fee for the level of service to be provided? (e.g., fixed fee, percentage of gross revenues or net operating profit, or a combination of the three with a base fee with upside earnings to reward good performance)
In addition to the Management Fee, a manager will also receive reimbursement for its expenses related to managing the hotel (which may include salaries, wages and benefits of the manager’s employed personnel, charges for services made available to the hotel by the manager on a centralized basis, sales and marketing expenditures for the hotel, non-capital expenditures for repairs and replacements, capital expenditures, and other operating costs for the hotel.
- 6.2 Must minimum performance thresholds be met for the manager to receive its full management fee? (or to receive some portion of an incentive fee, such as a "catch-up" fee if some performance thresholds are not met but others are)
- 6.3 Will the manager be allowed to share in profits or will the manager’s compensation be capped? (e.g., a sharing of profits above a specified threshold, the management fee may be capped at a set figure, or the manager may only receive a specified bonus if the hotel achieves net operating income at specified levels)
- 6.4 Have any thresholds been established for hotel performance? (e.g., RevPAR, RevPAR index, GOP margins, GOP index, profitability milestones, and performance against budget and prior year)
- 6.5 What is the relationship between the owner and manager when there are disputes regarding performance, jeopardy clauses, or financial incentives based on minimum performance thresholds?
Negotiating a Hotel Management Agreement
Negotiating hotel management agreements can sometimes prove difficult because it is often necessary to be pragmatic and balanced when handling requests for concessions, and an unreasonable request can often result in the collapse of a deal. Striking the right balance during negotiations can improve the chances of completing a deal, although over-compromising especially at the beginning of the process can be detrimental and puts the hotel owner at risk of being taken advantage of.
BEFORE NEGOTIATIONS
Prior to commencing negotiations, the owner and the operator should be aligned on commercial issues, such as expected revenues and expenses, the budget process and the operational independence of the operator. It is also important that the operator is capable of delivering the expected results. Before discussing contract terms, consider whether to have key commercial terms agreed in principle, particularly if egos are likely to get involved once negotiations begin. An example of such an approach is to pre-agree a sort of heads of terms (perhaps on a site plan), but be careful that they do not become binding.
DURING NEGOTIATIONS
Understandably, the operator will try to maximise its own position during negotiations, while the owner will try to retain control and influence. There must be a reasonable balance between the content of the contract and what is discussed. For example , the contract will set out the scope of services to be provided by the operator, so there is little need to discuss those services in detail. However, if the characterisation of license fees and incentive fees is amended when introducing new terminology, the new terminology will need to be defined in the contract. Another example of balancing a commercial and legal decision is the decision on renovations. The use of owner approved reserves allows the operator to keep its cash flow positive. However, it is natural for an operator to favour excessive owner contributions to renovations. In contrast, the owner will want to ensure that renovations are not excessive and are covered by the license fee. It is worth noting that things to consider during negotiations may not necessarily make it into the contract. For example, it may be unreasonable to expect the operator to appoint staff from the local area where the hotel is built. Similarly, if the operator is to apply for a new franchise, the owner will want to be consulted before the agreement is entered into. We recommend that the most contentious issues are resolved near the end of negotiations to avoid inadvertently introducing an inconsistency elsewhere in the contract, as everyone will have less focus at the end of negotiations.
Legal Aspects and Common Issues
Like any other commercial agreement, hotel management agreements may be subject to legal disputes. A dispute under the terms of the hotel management agreement arises in circumstances where the hotel owner, developer or lender believes that the operator is not complying with the terms or covenants of the hotel management agreement, or vice versa.
There can be a range of remedies arising out of the breach of a contract, including a final decision by the Arbitrator in the context of an arbitration, or a judgment delivered by a judge of the Court after proceedings have been brought before the Court. The Court has the power to rescind a hotel management agreement by way of a declaration that the hotel management agreement is invalid or unenforceable in circumstances where the Hotel Manager or Owner were acting in a manner inconsistent with the statutory requirements of the law.
Execution of hotel management agreements is also sometimes a challenge for foreign entities who wish to operate an international hotel brand. Often, Governments will have obligations and interventions in a particular country, which may be inconsistent with the operators’ proposed branding, reservations, and other standards. Government Restrictions may sometimes hinder the hotelier from using its preferred systems, and its ability to employ expatriate staff. Foreign ownership restrictions can be addressed with local entities, but it should be noted that some financial institutions and lenders will have restrictions on the extent to which they will lend to foreign entities, and will have a preference to lending to companies incorporated in the relevant country.
Current Trends and Developments
The continuing expansion of the sharing economy, with companies such as Airbnb disrupting the operations of many hotels, has caused many owners to evaluate the terms of their hotel management agreements. Specifically, owners have been focused on whether their managers are able and willing to participate in their response to the challenge of their competitors in the sharing economy.
New benchmarking studies are emerging mainly because of the growth and diffusion of larger hotel ownership groups, including private equity groups. These large ownership groups often own multiple properties governed by different managers which introduces the need for benchmarking to identify opportunities to improve financial performance on a property-by-property basis . Emerging practice among larger owners is to conduct annual financial performance reviews for each of their properties and use these reviews to analyze each property’s performance against similar hotels identified by description, location, cluster, etc. In some cases, performance reviews are conducted with a third-party advisor.
With a downturn looming later in this cycle, and with the disruption from the sharing economy and a new generation of owners who have the financial resources to aggressively acquire more properties (which will grow the number of total competing hotels), it is likely that we will see a wave of negotiations over the current provisions of existing management agreements and potentially new agreements over the next several years.