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Tips from hotel franchise and management lawyers: Beware the trap of “changing brand standards”

8 September 2011

Hotel Lawyer on changing brand standards.

Hotels need brands, and brands need hotels.

Like all relationships, the relationship between branded hotel operators or franchise companies (the brand) and hotel owners needs ground rules. As long as both parties agree to the rules and follow them, who can complain?

Now, what happens if the ground rules change? In most relationships, both parties would agree to change the rules — or they would separate and go their own ways.

And what if one of the ground rules is that only one party can change the rules at any time? And the other party would have to follow them, no matter what? This is what can happen to hotel owners that agree, often for very good reasons, that a brand can change its standards for the hotel.

Sometimes the change in brand standards is not so good for the owner… one day you’re turning a profit and the next day you’re in the hole, paying for expensive changes required by the “new brand standards,” with no return on investment in sight.

The management or franchise agreement sets the ground rules and allocates risk between the hotel operator and the hotel owner. Negotiating the agreement, which will include “brand standards”, is one of the most important things hotel owners will ever do for their hotel investment.

Here is some advice from my partner, Robert Braun, co-author with me of the HMA Handbook.


The Shifting Sands of Hotel Brand Standards
by
Robert E. Braun | Hotel Lawyer, JMBM Global Hospitality Group®

The hotel market in the United States is dominated by brands. And whether associated with a brand or not, hotels are commonly measured against established brands. The ability to finance a property may be determined by the availability of an established and successful brand, and the ultimate success of a hotel may depend on the strength of the reservation system, marketing, and other support provided by the hotel brand.

One of the consistent themes to all brand management or franchise agreements are “brand standards.” They are designed to provide the common feeling or identification which allow all hotels under a common name to be recognizable as part of the brand, eliminating inconsistencies and providing for a reliable guest experience, which should, in turn, create loyalty to the brand. From the owner’s point of view, these standards provide stability and are key to determining the proper brand – a developer or purchaser selects a brand largely based on whether that brand will meet the market for which the hotel has been designed.

But what happens if the brand changes its standards?

How can Brands change their standards?

The answer is simple – the brands put it in their franchise and management agreements. While the exact wording may differ from agreement to agreement – a “system” in one agreement may be a “standard” in another – every agreement provides that the brand may change its standards, and the owner must comply with those new standards.

Why change standards?

Brands usually have good reasons for changing their standards and systems. Doing so can be key to achieving the goal of a consistent guest experience and guest loyalty. If individual hotels were to make decisions as to amenities, a guest would never know what kind of hotel he or she would be visiting and would have less reason to prefer one brand over another.

In addition, standards for different classes of hotels tend to evolve over time, and modifying standards may be essential to remaining competitive. A hotel that may have been considered “midscale” ten years ago would only be a competitive midscale hotel today if it incorporated the technological and other changes that have been adopted by other hotels in its class. For example, few, if any, hotels had Internet access or flat screen televisions twenty years ago; those are now standard marketing tools for brands.

What can go wrong?

It all sounds good, but it’s not always a happy story. Sometimes, a brand may choose to make broad changes to its standards that force owners to face an expensive dilemma. They must either spend large, sometimes extravagant, funds to remain in compliance with the brand standards, or violate the terms of the franchise or management agreement, risk termination and pay even more expensive termination fees.

One of our clients recently faced this dilemma when it was notified that the property would require design changes to meet new brand standards. This change came despite the fact that the brand had already approved the plans and the hotel was well into construction. Furthermore, the changes would violate agreements with lenders and the city! We were able to negotiate a temporary reprieve, but it is clear that this story hasn’t yet ended.

Changing classes

The problem can also come up when a brand makes a conscious decision to upgrade, or downgrade, the status of its brand from one class to another. As reported recently, Intercontinental Hotel Group decided to upgrade its Crowne Plaza® brand from an “upscale” brand to an “upper-upscale” brand. As reported in HotelNewsNow.com, Janis Cannon, Vice President of global brand management for Crowne Plaza said, “We’re following what we call our ‘Rest to Best’ strategy where we want to get all of the hotels to move up to where the top-performing hotels are. There are plans to remove hotels from the system. It’s either move up or move out.” IHG expects that 10% of the hotels in the Crowne Plaza system “won’t fit the mold” and will be removed from the system. (See IHG to Crowne Plaza owners: Move up or move out.

When that happens, the owners’ dilemma is even greater. Not only must they consider the viability of implementing significant upgrades, they need to consider whether the new classification, which will inevitably change the economics of the flag, is consistent with their business plan. An owner that selected Crown Plaza specifically because it was an upscale hotel will have to either compete in a different environment, or negotiate an exit from the system and, most likely, reflag the hotel, often at considerable cost.

Why does this happen?

Owners should remember that decisions as to brand standards are made without regard to the individual hotels in the portfolio; they are made on a brand basis, with the overriding goal of maximizing the value of the hotel brand, not the hotels that make up the brand. While hotel brands typically do respond to their franchisees and property owners, they clearly retain the last word, and will impose their decisions.

What can I do?

While brands are very protective of their ability to modify their systems and standards, there are a few basic steps an owner, or prospective owner, can take to guard against these results.

If you are already signed up with a brand, you should diligently follow brand developments. Take advantage of owners’ groups and respond to indications that a brand may be preparing for a meaningful change.

Anyone thinking about a hotel franchise agreement or management agreement should consider these steps:

  1. Consult with hotel franchise attorneys with lots of experience in dealing with the brands. It may be possible to negotiate limited, but meaningful, concessions, such as an agreement not to change the classification or scale of the brand, limit changes which would require structural revisions to the property, or require the brand to take into account the particular location and circumstances of the property.
  2. Get someone with experience and practical judgment. You want someone who knows where to spend the “political capital.” There is no sense in fighting over provisions you will never be able to change, and you need reasonable positions and fallbacks.
  3. Most importantly, consult your hotel attorney EARLY in the process — BEFORE you start exchanging term sheets or drafts of the letter of intent. Once that process has started, it will be very difficult to get any material changes in terms, even when your negotiations and term sheets are “non binding.”

Negotiating a hotel management or franchise agreement is one of the most important things hotel owners will ever do for their hotel investment. The terms of the agreement will have a significant impact on critical areas that affect profitability: operating costs, financing, and the value of your hotel.

Get it right the first time!

Consulting a hotel attorney early in the process and “getting it right the first time” is advice based on more than 20 years experience we have had in negotiating, re-negotiating, litigating, arbitrating and advising on more than 1,000 hotel management and franchise agreements on behalf of hotel owners, with all the major brands.

Go to the Management and Franchise Agreement section of the Hotel Law Blog to read more about the critical importance of hotel management and franchise agreements.

The HMA Handbook: Hotel Management Agreements for Owners, Developers, Investors and Lenders includes a section on “What You Need in Your HMA” and is available free of charge to hotel owners, developers, investors and lenders.

This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We’ve done more than $60 billion of hotel transactions and have developed innovative solutions to help investors be successful in bidding for hotel acquisitions, and helping investors and lenders to unlock value from troubled hotel transactions. Who’s your hotel lawyer?

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Robert%20Braun%20photo%206-20-10.jpg

Robert Braun is a senior member of the Global Hospitality Group® at JMBM. Mr. Braun advises hospitality clients with respect to management agreements, franchise agreements and spa agreements. He also advises on business formation, financing, mergers and acquisitions, venture capital financing and joint ventures, telecommunications, software, Internet, e-commerce, data processing and outsourcing agreements for the hospitality industry. Contact him at 310.785.5331 or rbraun@jmbm.com.

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Our Perspective. We represent hotel lenders, owners and investors. We have helped our clients find business and legal solutions for more than $60 billion of hotel transactions, involving more than 1,300 properties all over the world. For more information, please contact Jim Butler at jbutler@jmbm.com or +1 (310) 201-3526.

Jim Butler is a founding partner of JMBM, and Chairman of its Global Hospitality Group® and Chinese Investment Group™. Jim is one of the top hospitality attorneys in the world. GOOGLE “hotel lawyer” and you will see why.

Jim and his team are more than “just” great hotel lawyers. They are also hospitality consultants and business advisors. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them.