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Hotel management agreement terminations — Is there a better way?

28 April 2010

Keywords:

Hotel Operating Agreement, HOA, Hotel Management Agreement, HMA, Hotel Management Contract, Management Contract. Hotel Operator, Hotel Manager, Hotel Owner. RFP for Hotel Manager. RFP for Hotel Operator, How to get a great hotel operator.

Terminology

Contracts between hotel owners and managers (or operators) controlling the management of a hotel go by various names. They are called hotel management agreements, HMAs, hotel management contracts or hotel operating agreements. For convenient reference, this article will generally use the term “Hotel Management Agreement” or “HMA.” However all these terms can be used interchangeably and mean the same thing, just as with hotel operator or hotel manager.

Whatever they are called, Hotel Management Agreements allocate risk between the hotel manager and the hotel owner. They are critical in determining the profitability and value of a hotel.

Hotel Management Agreement disputes are on the rise! The recent announcement about Banyan Tree Hotels & Resorts terminating its management contract at Banyan Tree Al Areen resort in Bahrain are amongst the latest proof of this trend

Hotel management agreements are a key factor in the success and value of a hotel — getting the right operator and a fair hotel management contract. And articles on hotel management contracts are some of the most frequently viewed items on www.HotelLawBlog.com. We have a rich library of resources on this topic – everything from “How to get a great hotel operator” and “ Helping Owners Strike a Fair Deal: 5 Milestones Marking The Road To Success For Hotel Management Agreements” to “How to terminate a hotel management agreement when an operator really deserves it!” or “Terminating hotel management agreements when things don’t work?.
A version of this article was first published on 28 April 2010 by Hotel Management Asia, a Questex Asia Ltd. publication, under the title, “Comment: Jim Butler on Hotel Management Agreements.”


There is always a natural tension between owners and operators . . . [which is] always aggravated in bad times – particularly at high end and luxury properties.

Terminating Hotel Management Contracts when the manager-owner relationship fails.

Hotel Management Agreement disputes are on the rise! The recent announcement about Banyan Tree Hotels & Resorts terminating its management contract at Banyan Tree Al Areen resort in Bahrain is amongst the latest proof of this trend, which is symptomatic of a deeper malaise.

In the case of Banyan Tree Al Areen, the manager claimed that the owner breached its obligations and wrongfully took over operations at the property. The resort has since been renamed the “Al Areen Palace and Spa”, and Al Areen, the property’s owner, is considering its options, which may include filing legal proceedings against the luxury resort operator for breach of contract.

Why are hotel owners and hotel managers fighting over hotel management agreements?

JMBM’s Global Hospitality Group® has a lot of insight in this area. It comes from more than 20 years experience in providing legal and advisory services to hotel owners, hotel developers and hotel lenders in more than $60 billion of hotel transactions involving more than 1,000 properties all over the globe. In that time, our hotel lawyers have negotiated, re-negotiated, litigated, arbitrated and advised on more than 1,000 hotel management agreements.

We do not find the increase in disputes between hotel owners and operators to be at all surprising. There is always a natural tension between owners and operators which have some aligned interests, but also some very conflicting interests. The conflicting interests are always aggravated in bad times — particularly at high end and luxury properties. This is when owners, facing huge debt service obligations on their multi-million dollar properties, seek to cut costs. But typical high-end branded hotel operators – such as Banyan Tree, Mandarin, Peninsula, Six Senses, Four Seasons, Ritz Carlton, St. Regis, Park Hyatt and the like — seek to maintain their revenues and maintain their brand reputation . . . at any cost (to the property owner). The same is also true in most full-service branded hotels of any significance.

These long-term hotel management contracts are supposed to give the owner and its lender the benefits of the brand’s reputation, reservation system, and marketing experience. But when things go badly, these agreements can be punitive to struggling owners.

The operator’s extensive control over the hotel gives the operator all the benefits of ownership with none of the burdens. And as long as the owner is paying for it, why shouldn’t the operator maintain its income and burnish its image? The operator typically has virtually total control over the hotel asset — running the hotel, hiring and firing employees, setting pricing and standards, telling the owner when to write checks for new FF&E, maintenance and upgrades or even to pay ongoing operations.

In one recent situation we reviewed, a luxury hotel costing $600-700,000 a key was generating approximately $60 million in gross revenue, but only $1 million in net operating income. And that was in 2007, BEFORE the hotel industry fell off the cliff! So imagine how negative the cash flow went in 2008 and 2009. The hotel has since been closed by the lender because the operator could not drive sufficient revenue and eliminate enough costs to maintain a viable hotel operation.

But when owners (or the lenders who take their property) want to stop the pain, and replace the operator with another that can maintain a viable hotel, a battle of epic proportions looms close. Hotel operators want to maintain the annuities represented by the hotel management agreement that may run for another 50 to 75 years. A typical hotel operator actually receives approximately 12-14% of the gross cash flow of a high end hotel – not all pure profit, but for services that sustain brand operations like marketing, reservations, chain services, purchasing, insurance, and similar items. Whether there is a profit or not to the operator, the payments to the operator are “off the top” or a percentage of gross — before debt service or any profit to the owner.

Publicity on hotel management agreement termination disputes
When possible, we have always found that the best way to handle owner disputes with a lender is privately — out of the press and the courts. But recently, an increasing number of disputes — like the Banyan Tree fight over the Al Areen property — have become so contentious that they are fought in the media as well as in court.
Other similar matters include the Four Seasons Resort Aviara, north of San Diego, California, where Four Seasons was terminated based on claims of mismanagement but refused to hand the property over to the owner. In this case, an arbitration panel has just determined that the management contract is terminated and allocated blame to both parties. Another battle, still unresolved, involved the storied Turnberry Isle Resort and Club in Aventura, Florida, where the owners sued the operator for a return of fees based on claims of mismanagement, where we advised the owner.

We have developed some very effective tools for dealing with long-term hotel management agreements that are no longer working for the owner. We call this collection of tools the SAVE® program (“SAVE” stands for Strategies and Approaches for Value Enhancement”).

And we recently assisted the owner of the Ritz-Carlton Bali on a strategy that successfully terminated a long-term management agreement with Ritz-Carlton without penalty and awarded a multi-million dollar judgment after a public dispute between ownership and management. (In this case, one of our clients owned the Ritz-Carlton Bali which was managed under a typical long-term, no-cut management contract. After a 3 week trial, a jury ruled that the management contract was breached by Marriott International and Ritz-Carlton, giving the owner the right to terminate the contract and awarding the owner over $10 million in damages. The action was based on hotel management agreement litigation involving competition against the hotel from another property managed by Marriott (as a Bulgari) near the Ritz-Carlton Bali.)

JMBM’s SAVE® program for troubled hotels and troubled hotel loans

When a luxury hotel owner decides to terminate a branded management contract, it usually faces the threat of hotel operator claims for a staggering amount of damages, possibly equal to the unpaid fees for the entire remaining term of the management contract. These long-term hotel management contracts are supposed to give the owner and its lender the benefits of the brand’s reputation, reservation system, and marketing experience. But when things go badly, these agreements can be punitive to struggling owners.

Often, operators overlook the optimistic projections they used to entice owners to sign long-term hotel management agreements. They also ignore their own inability to generate sufficient revenues to cover a hotel’s operating costs such as payroll and utilities, much less the mortgage on the property. And as the owner continues to struggle to pay operating shortfalls by supplementing hotel revenues with other cash resources, the operators often seem oblivious to these realities, demanding extravagant expenditure s to maintain the brand’s lofty sense of brand standards — without regard to the cost-benefit impact on customer experience or expectations, much less the property’s profitability.

Most hotel operating agreements are not terminable at will by the owner or merely because the hotel is underperforming. We have developed some very effective tools for dealing with long-term hotel management agreements that are no longer working for the owner. We call this collection of tools the SAVE® program (“SAVE” stands for Strategies and Approaches for Value Enhancement”). The reference to “value enhancement” relates to the fact that while the right management agreement can add a lot of value to a property, in times like these, a long-term, no cut, hotel management agreement can be a big “encumbrance” on value. In fact, we have seen a number of real-life situations where hotel is worth up to TWICE as much without the branded hotel management agreement.

There are at least three ways to terminate a long-term, no cut, hotel management agreement . . .

When things are not going well at a hotel, we first work with a qualified hotel consultant to figure out WHY things are not working. The SAVE® program is a cooperative and pro-active approach that brings analytical diagnostics to the troubled hotel or hotel loan situation and evaluates options to improve revenues, control costs, manage CapEx and, if necessary, deal with legal options. Along with the operational analysis, we give careful consideration to the operator’s performance. What can be done cooperatively with the operator to improve results? Is this the right operator or just difficult times for everyone? Is there some win-win for all parties other than termination? We help clients identify and evaluate the options and select the right one. This is the benefit of understanding hotels from a business standpoint in addition to a thorough understanding of the legal issues.

Terminating a hotel management agreement without liability

When our client makes an informed decision that it is indeed time to terminate a management agreement, then we undertake the analysis of the least painful way to accomplish such termination.
There are at least three ways to terminate a long-term, no cut, hotel management agreement – other than pursuant to express terms (e.g. by expiration of term, termination on sale, termination windows or options, and the like). In general, they are as follows:

  1. Negotiate. Talk to the operator and see if they will walk away as a matter of honor, or fairness, or possibly a trade-off of value. We have been able to accomplish this in a number of significant matters. Sometimes an agreed upon payment bridges the gap.
  2. Terminate the hotel management agreement for breach of contract or breach of fiduciary duty. These are subjects far deeper than one might initially suspect. We specialize in evaluating situations in these areas, and have successfully advised many clients and written a number of articles on these subjects over the past decade.
  3. Terminate the hotel management agreement by “rejection” in owner’s bankruptcy. While the analysis here will obviously be based on applicable bankruptcy laws, a bankruptcy court is usually a court of equity that seeks to protect a debtor, and a management agreement is usually an “executory contract”.

Such contracts usually can be rejected, as a matter of law, in bankruptcy by a debtor, and on rejection, the injured party (i.e. the management company) usually becomes an unsecured creditor in the bankruptcy. Where the value of an asset is less than the amount of the senior encumbrance, the hotel operator stands in line with all the other unsecured creditors and receives nothing or whatever amount is negotiated to facilitate the bankruptcy. By this process, potentially tens of millions or hundreds of millions of dollars of damages are converted to nothing or pennies on the dollar.

So why doesn’t everyone file bankruptcy and terminate their management agreement using the third approach above? That is a very good question and one that should be asked more often. (See Hotel bankruptcy trump card. Terminating hotel management agreements without liability — the alchemy of lead to gold for troubled hotels and hotel loans? ” The bankruptcy rejection solution above requires that the hotel be “underwater” i.e., that the value of the hotel is less than the value of the secured debt on the property. Also, as stated above, termination is not always the right answer. Sometimes a less destructive business solution can be reached.

Final thoughts on terminating hotel management agreements

To avoid getting to a place that you feel you need terminate a management agreement, it is important for an owner to select the right operator, protect itself up front by negotiating a fair management agreement, and resolve potential disputes early. If these protections do not work, then bring in the experts to help resolve the dispute between owner and operator or, if necessary, terminate the management agreement.
For additional resources on Hotel Management Agreements, see the Hotel Law Blog’s rich library of resources on the topic at Hotel Management Agreements.

Other articles on Hotel Law Blog about terminating hotel management agreements

Marriott Loses Appeal in Eden Roc Case: Why all long-term hotel management agreements are now terminable

How to terminate a hotel management agreement: A Tale of Two Hotels — Marriott’s Edition Waikiki and Fairmont’s Turnberry Isle Resort

Terminating hotel operators: M Edition lawsuit against Marriott has a new twist — Marriott is replaced overnight

More on M Waikiki Edition lawsuit against Marriott – What Marriott’s General Counsel says

M Waikiki’s Edition lawsuit against Marriott and Ian Schrager – an owner’s HMA dispute with Marriott

Terminating hotel operators: Turnberry Resort drops Fairmont flag

Hotel management agreement terminations — Is there a better way?

Terminating hotel management agreements when things don’t work? Not easy, but not impossible either.

Hotel bankruptcy trump card. Terminating hotel management agreements without liability — the alchemy of lead to gold for troubled hotels and hotel loans?

Ritz-Carlton Bali hotel management agreement termination further court order

Ritz-Carlton breached contractual and fiduciary duties under hotel management agreement giving rise to free termination, $10.3 million in damages plus attorneys fees. When will hotel operators “get it?”

How to terminate a hotel management agreement when an operator really deserves it!

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 unlock value from troubled hotel transactions. Who’s your hotel lawyer?


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 1,000 properties all over the world. For more information, please contact Jim Butler at jbutler@jmbm.com or 310.201.3526.

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

JMBM’s troubled asset team has handled more than 1,000 receiverships and many complex insolvency issues. But Jim and his team are more than “just” great hotel lawyers. They are also hospitality consultants and business advisors. For example, they have developed some unique proprietary approaches to unlock value in underwater hotels that can benefit lenders, borrowers and investors. (GOOGLE “JMBM SAVE program”.)

Whether it is a troubled investment or new transaction, JMBM’s Global Hospitality Group® creates legal and business solutions for hotel owners and lenders. They are deal makers. They can help find the right operator or capital provider. They know who to call and how to reach them.