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Hotel Management Agreements: Key issues for owners

If a hotel owner decides to bring in a management or operating company to run its hotel business then its main concern will be to find one that has the correct 'fit' for its own hotel. A well established track record in similar hotels, expertise in key areas and a competitive fee structure will be important considerations in establishing which of the many quality hotel operators is best suited to that particular hotel.

However, the Hotel Management Agreement itself should not be overlooked and, once the correct operator is chosen, an owner should not simply sign up to the operator's standard document without careful consideration of its terms. Operators are willing to vary and negotiate their standard forms where appropriate for the circumstances. Indeed negotiating a well-structured and customised Hotel Management Agreement should bring benefits to both the owner and operator of a hotel by clearly setting out roles and responsibilities and flushing out any areas of potential dispute at an early stage.

This article highlights some of the key issues for owners when negotiating a Hotel Management Agreement. These issues are not exhaustive however and professional advice should be sought in each case. The crucial point is to ensure that the Agreement properly reflects the particular circumstances of the hotel.

Control and Key Performance Indicators

Two of the main purposes of the Agreement are clearly to free up the owner from the running of the business and provide the operator with the rights, powers and authorities it needs to make a success of the business. However, those rights should not be unchecked and an owner (even one that is looking for a "light touch" of control) should always look to build in appropriate protections. Those protections can vary depending upon the nature of the hotel's business but will typically include:

  1. a budget approval mechanism, with clear resolution procedures if the budget cannot be agreed;
  2. review meetings at appropriately regular intervals;
  3. a sensible process for agreeing the accounts of the business (which will be particularly important for calculating the fees);
  4. protections against certain types of loss, where this has been caused by the owner;
  5. and a list of reserved matters that require the owner's consent (while not interfering with the operator's day to day running of the business). Bespoke matters relating to the particular hotel should always be considered, together with the more usual ones that are generally accepted in the hotel and leisure sectors.

Additionally, KPI's are often included to help measure, evaluate and control the operator's performance. In particularly serious situations, KPI's can be used by the owner to remove an underperforming operator. However, it is important that such termination rights are very carefully drafted to ensure they are practical and do not harm the underlying business.

Fees

One of the most important controls is ensuring that the fee structure is correct. The Agreement should have clear and achievable commercial incentives so that both parties are pulling in the same direction.

There are many types of fee structures used in Hotel Management Agreements but typically the fees can be put into three broad categories:

  1. a fixed fee or one based on a percentage of turnover;
  2. an incentive fee based upon the profit of the business;
  3. and other charges relating to e.g. marketing services, reservation systems and certain licences.

Fixed fees or ones based on a percentage of turnover are relatively standard but it may well be that operators are willing to forego higher fixed / turnover fees, if they can secure longer terms and/or more attractive incentive fees.

Incentive fees sit alongside the fixed fee arrangement but will be more detailed. They can take many forms and be based upon different measures of profit (often Adjusted Gross Operating Profit or a form of Net Operating Profit). The percentage of such fees may also rise during the term of the Agreement if there is appropriate commercial justification for doing so. The detail of the drafting is clearly important and the calculations and definitions should be carefully checked, e.g. to ensure that they properly allocate which costs are operating costs and which are ownership costs.

The final types of charges mentioned above (i.e. relating to other specific skills, services and assets of the operator) are often linked to rooms revenue but again should be checked to ensure they are suitable and are not already reflected in the other fees.

Guarantees

Sometime operators still offer to guarantee a certain level of profit. While this may seem attractive to an owner, the terms of it should be carefully considered as often a higher fee is attached to such a guarantee.

Term, renewal periods and exit

The initial term of a Hotel Management Agreement will vary from case to case, often due to the respective bargaining positions of the parties. A more-established operator will generally look for, and be able to secure, a longer initial period. Nevertheless, the owner should be comfortable that the fees properly reflect any unusually long initial period.

Renewal periods (e.g. for subsequent 5 year periods) are commonly set out in the Agreement, although will usually require both sides to agree the renewal at the relevant time.

Owners should also be careful that the Agreement does not frustrate their ability to exit should a suitable opportunity arise. The processes for allowing such exits can require detailed negotiation and drafting to ensure that both parties are comfortable with the position.

Third party issues

A Hotel Management Agreement should not be considered in isolation. Frequently, Leases and Franchise Agreements, as well as other funding and commercial agreements, will be involved and the Hotel Management Agreement should appropriately dovetail with them. Such agreements should also be checked for any relevant consents that may be required (and the obtaining of those worked into the timescale of the operator commencing its management of the business).

Non-competition

An owner will usually want some comfort that a competing hotel operated by the operator's group will not be opened in close proximity to its own hotel. That general principle may be acceptable but operators will be keen to ensure that it still has flexibility and, for example, that such a restriction does not interfere with any of its other brands which are not true competitors (e.g. budget as opposed to higher end brands). Other facts, particularly the hotel's location, will also impact upon the scope of such non-competition provisions.

For further information

If you wish to discuss any aspects of a Hotel Management Agreement or any other commercial arrangements in the Hotel, Tourism & Leisure sectors (including franchise arrangements, joint ventures, acquisitions and disposals), please contact the DWF Hotels Team.

The DWF Hotels Team are leading legal advisor to the hotel sector and deal with all legal aspects relating to the sector, including Development and Construction, Management and Operations, Franchising, Leases and Real Estate, Employment, Finance and Investment throughout the UK.

Alasdair Peacock

Partner - Head of Corporate Services

I have extensive experience in corporate and commercial law managing teams of lawyers both in industry and in private practice.

Alan Walker

Partner - Head of Real Estate Litigation (North West)

I advise on all aspects of commercial property law, including contested and uncontested lease renewals under the Landlord and Tenant Act 1954, service charge disputes, dilapidations and alienation problems, and the enforcement of covenants/wayleaves.

Chris McLeish

Partner

I am a partner in the Real Estate Team in Glasgow. I deal with a wide range of real estate matters but focus on real estate investment and the healthcare sector.

David Scottow

Director - National Head of Recoveries

I am a Senior Director and National Head of Recoveries with almost 40 years’ experience in debt litigation, insolvency and credit management..

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Iain Thomas

Partner - Head of Real Estate Finance

I am a Partner in the Real Estate team. I head the Real Estate Finance team and have over 20 years' experience acting for lenders in real estate financing and restructuring.

Jeremy Steele

Partner

I provide a broad range of property management advice to investors and occupiers with the aim of resolving disputes as swiftly and cost effectively as possible, whilst preserving or enhancing the investment value.