By Daniel R. Weede
Choosing a hotel brand and a hotel manager are two of the most critical choices hotel owners can make, but many don’t fully understand the key hardware issues or try to negotiate their franchise agreements and Management. This article discusses essential and frequently negotiated issues in these agreements.
Hotel franchise contracts
To maximize RevPAR (and secure capital and funding), owners typically contact a major hotel brand to “brand” their hotel with an appropriate hotel brand. The correct flag can dramatically increase hotel occupancy and room prices, and add 20% to 40% to a hotel’s value compared to “flag-less” or lower branded options. . The document that formalizes your rights and obligations is the hotel license contract or the franchise contract. There are dozens of material conditions in the franchise agreement; however, the vast majority of these terms are non-negotiable. The key to successfully negotiating with a brand is understanding which terms are open to negotiation in certain situations.
Although very few legal terms of the franchise agreement are open for negotiation, if they are raised during the negotiation of the terms sheet prior to the committee’s approval by the brand, there are several business terms that owners have a. some ability to negotiate. The owners have more leverage in economic terms if they develop the hotel instead of buying a stabilized asset. The conditions considered as commercial conditions and likely to be the subject of negotiations are as follows:
- Key money (in development agreements)
- Protection zones (in development agreements)
- Rise in royalties (in development agreements)
- Special termination rights in the event of failure to obtain funding (in development agreements)
- Removal of the trademark’s rights of first refusal
- Pre-approval of the management company brand or ownership structure
- Construction start date and opening date (in development agreements)
- Guarantor brand pre-approval
- Limitation of the guarantor’s liability
The ability to gain brand concessions is largely dependent on the influence of the owners (i.e., does the owner develop a new hotel or agree to carry out a renovation? major? Does the owner have several other hotels within the brand’s family?) and knowledge of the issues. An experienced hospitality lawyer or hotel consultant can help owners participate in negotiations.
Hotel management agreements
A hotel management contract establishes the basic relationship between an owner and his agent / operator of a hotel property. Because a hotel manager oversees the day-to-day operations of the hotel, including employee relations, reservations, marketing and maintenance, it is essential to negotiate the rights and obligations of the owner and manager in relationship with the duties of the manager.
In most cases, the initial draft management agreement is provided by a potential hotelier to a hotelier. It typically gives managers a long-term right to operate the hotel with largely limited owner involvement in the annual budget approval process. However, unlike franchise agreements, when negotiating a management agreement, the owners have more weight in the transaction. Savvy owners can often demand that a manager agree to major revisions to their standard form of management agreement.
Key material terms of a management contract:
- Term: The length of office is often the most critical of all business matters. The initial terms are usually much shorter in management agreements with third parties. Shorter terms allow owners to quickly switch to another manager if that manager doesn’t address the owner’s concerns or if the hotel is underperforming. Shorter terms mean lower legal fees as lawyers will have to spend less time negotiating performance tests, performance standards, etc. Ideally, the hotel owner will want to negotiate as short a term as possible (2-10 years for unbranded managers and 10-20 years with branded managers).
- Fresh: These include basic fees (often 2% -4% of gross income); incentive bonuses (often 10% to 20% of income after debt service); cap on fees; and subordination of costs to the mortgage. An incentive compensation structure based solely on gross income can create a conflict of interest between managers and owners, and can incentivize managers to maximize gross income, regardless of whether or not it increases NOI.
- Alignment of operator interests / incentives: There are many ways for parties to do this, including shared investments, key capital, NOI or GOP guarantees, or negative operating cash flow guarantees.
- Limitations of the operator’s authority: Savvy owners will also want to place specific limits on managers’ ability to perform large or long-term contracts, incur liabilities, engage in collective bargaining, or purchase goods from affiliates.
- Termination: (i) For cause; (ii) for sale; (iii) failure of the performance standard; (iv) for convenience (buyout clause); (v) by the owner for inability to obtain financing or to open; (vi) bankruptcy.
- Damage: Does the manager have claims for damages beyond specific and limited damages? Does the manager have specific performance rights?
- Operating standard: The agency law should govern all management agreements and managers should have fiduciary obligations to the owner; managers should be required to make commercially reasonable efforts to maximize the NOI.
- Budgets: (i) Content; (ii) schedule; (iii) the owner’s approval rights on the operating budget and the investment budget. The owner wants to control costs, the managers want sufficient discretion to incur the expenses necessary to operate the hotel according to the standards of the brand. A fair compromise allows owners to review, approve and demand changes to the budget prepared by managers, without unreasonably restricting the managers’ ability to operate and maintain the hotel within the operating standards of the managers. the brand.
- Reports / inspections: (i) Periodic reports, annual reports, flash reports; (ii) audited financial reports; (iii) owner’s right to inspect and audit both finances and operations.
- Employment matters: (i) Who is the employer; (ii) union issues; (iii) the WARN law obligations upon sale / termination; (iv) approval of the general manager and executive staff by the owner; (v) the rights of managers to negotiate severance pay and union agreements. Typically, owners will want hotel employees to be the manager’s employees. Owners must retain the right to hire, or have hired by a replacement management company, all hotel employees upon expiration / termination of the HMA and the right to review and approve compensation for employees (apart from hotel income).
- Licenses and permits: (i) Who is responsible for obtaining and maintaining them; (ii) what are the consequences of failing to maintain a license; (iii) unique liquor license issues (if the manager holds, what obligations must he / she cooperate with the sale or in the event of foreclosure?).
- Lender / SNDA protections: (i) Obligation to sign a contract with current and future lenders; (ii) are the costs subordinate (incentives compared to the base costs); (iii) subordinate to debt service (and not just the interest portion of debt service). To make the hotel more attractive to potential lenders, the management contract should contain certain provisions protecting the lender, such as allowing the lender to collect their debt service before the manager collects their fees when a default is paid. arose under the loan, allowing the lender to terminate the management contract upon the lender’s foreclosure on the hotel, an obligation to notify the lender in the event of a breach of the agreement and allowing the lender to remedy this breach on behalf of the owner after the owner has not remedied the deficiency during the initial repair period.
- Indemnity: Owners generally accept broad compensation from the manager, except in cases of gross negligence by a manager (and sometimes the CEO).
- Customer data: (i) Who owns it; (ii) liability for breaches; (iii) ensuring that managers comply with best industry practices.
- Self-negotiation / group services: Group services should only include services that can be provided more efficiently for the entire group of hotels managed by the management company rather than on a hotel-by-hotel basis. These services generally include reservation, accounting, payroll, and marketing and advertising services.
Daniel R. Weede is a shareholder in the Atlanta office of the law firm Carlton Fields. He has extensive experience representing hotel brands, owners, investors, developers, lenders and managers in all aspects of hotel ownership, management and financing. He is a co-founder and past president of the Atlanta Hospitality Alliance, an Atlanta-based hospitality industry networking and professional development group that meets quarterly to discuss hospitality industry trends and developments.
This is a contribution to Hotel company, written by an industry professional. The thoughts expressed are the point of view of the stressed individual.