Hotel Online  Special Report

.

The Global Hospitality Advisor

.
Hotel Franchise Agreements: Opportunities And Pitfalls


by Robert Braun, September 2004

Over the years, the hospitality industry has witnessed the ebb and flow of branded hotels in the marketplace. Not long ago, we rode the wave from branded to independent properties. But the tide has changed, and today brand power reigns. Along with this resurgence has come the increased use of franchise agreements (sometimes called license agreements) as an alternative to traditional management agreements. The sea change is visible across all service levels and product types—limited service, full service and even upscale brands— and it brings with it both opportunities and pitfalls for owners and franchisors.

The Owner’s Opportunity

Franchising provides owners with attractive opportunities: 

  • Access to the brand’s marketing muscle and reservations power. 
  • Greater operational control through self-management or management by an independent operator.
  • Facilitation of debt and equity financing (many lenders will not finance hotel construction or acquisition unless the property has a strong national brand). 
While fans of branded management argue that owners get professional management of their hotel and get to use the brand “for free,” the explosive growth in the ranks of independent management companies has proven that the two-tier system of franchise ownership and independent management can be profitable. Many owners have found independent management companies that will: 
  • Respond better to their concerns.
  • Generate more gross revenue.
  • Control costs better.
  • Provide more flexibility for investment strategies.
The Franchisor’s Opportunity

While a franchisor may not have the same day-to-day control over a hotel’s operations, the franchise option provides a vehicle for the franchisor to: 

  • Expand brand presence without significant investment.
  • Collect a lucrative profit stream of franchise fees and marketing revenues.
  • Save money, as franchise agreements cost less to negotiate and monitor than management agreements.
  • Save time and eliminate uncertainty, as franchise agreements are generally subject to less negotiation than management agreements.
  • Eliminate significant fiduciary duties and liabilities.
How Franchise Agreements Differ From Management Agreements
  • Franchisors have very few obligations (franchisors often provide in their agreements that they do not have any set obligations—their incentive to provide the services contemplated by the parties “rests in the marketplace”).
  • Potential franchisees have limited right to terminate an unsatisfactory franchise because of the franchisor’s failure to provide services or results without payment of a substantial termination fee.
  • Franchisees are obligated to pay franchise fees, observe franchise restrictions and maintain brand standards or suffer damages and termination.
  • Performance discipline is generally lacking as there are generally no incentive fees, or termination rights in favor of the franchisee for subpar or even dismal performance.
Franchisors are obligated to provide a uniform franchise offering circular (UFOC) to each potential franchise acquirer. The UFOC provides information on all the costs of a franchise, success factors, information about the franchisor, a copy of the standard form of franchise agreement and other key matters. Potential franchisees can use the UFOC as one tool for gauging the costs of a franchised hotel and the track record of a franchisee; however, due diligence should not begin and end with the UFOC; other steps, including interviewing other franchisees and site visits, cannot be overlooked.

Caveat: Franchise agreements are subject to various laws, and any agreement that meets the definition of a “franchise” can be subject to franchise regulation no matter what it is labeled. 

Negotiating Franchise Agreements 

As noted above, one reason that franchise agreements are increasingly popular is the standardization of the agreement. As a result, the negotiation of a franchise agreement is typically not as lengthy or detailed as the negotiation of a management agreement with a brand operator. At the same time, depending upon the pedigree and power of the brand, franchise agreements generally have more limited prospects for negotiation, but even with the strongest brand owners can productively seek important changes from standardized terms in the following areas:

Fees. Sometimes the normal fee structure can be modified. For example, a franchisor may be willing to reduce license fees to have a branded presence in a key location as operations are ramping up, or to help an owner with the burdensome costs of a brand conversion or a major capital improvement program.

Unique Hotel Characteristics. Critical issues of variance from brand standards may be negotiated in cases where franchises go beyond “plain box” properties to design-oriented, themed and boutique properties.

Property Improvement Plans (PIPs). If the franchisor requires a PIP, the terms are negotiable and should be considered carefully. (PIPs are often required when a property is converted from one brand to another, or from a managed property to a licensed or franchised property.) 

Territorial Restrictions. Franchisors will often agree to some reasonable limitation on their ability to operate or license competing properties, particularly in the early years of an agreement and where local demographics warrant it. In creating a non-competition area, franchisees should consider not only the named brand, but also related brands which may compete.

Termination. Franchisees should negotiate early termination provisions. Obtaining this provision may require the payment of liquidated damages, but may be particularly valuable in an attempt to sell the property. With respect to new construction, franchisees should look to reduce termination fees where the agreement might be terminated prior to, or shortly after opening.

Transfer and Assignment. The kinds of fees and PIPs that franchisors seek to impose at the time of transfer should be negotiated at the outset of the relationship. Franchisors typically want substantial control over the assignment of a license. Care should be taken to make this as broad as possible to consider additional investors and owners, reorganizations, as well as the outright sale of the property.

Guarantees. Franchise and license agreements often require performance guarantees as a matter of course, but franchisors will consider varying their policies in individual cases.

Approval of Management Companies. Where a third party manager will operate the hotel, the franchisee should seek flexibility in the right to engage new managers. 

While most franchisors are willing to make concessions in the areas noted above, franchisees should be sensitive to the potential to negotiate significant additional changes where a location is particularly important to the franchisor as part of its system; there are few other opportunities for development in the area; the franchisor is looking to expand its market share generally; and there is an ongoing relationship between a franchisor and franchisee (or the franchisee’s operation). Experienced, knowledgeable counsel can help identify these opportunities and optimize them. 

Start Early To Avoid The Pitfalls!

Bring your counsel and advisors on board early to avoid pitfalls and optimize results. Many franchisors limit negotiations to what is covered in a deal term sheet, so by the time a draft agreement is circulated, it is too late for meaningful input. Although non-binding, the term sheet limits the deal terms that many franchisors will consider. So if you don’t get your input at the very outset of the process, you will miss the opportunity for many enhancements that might otherwise be accomplished with relative ease.

This goes for some of the more critical deal terms noted above as well as other items that can prove important in a particular situation. The following are a few examples:

  • The franchisor’s obligation to keep information regarding the franchisee and its affiliates confidential.
  • Ownership of information obtained from the franchisee or about the hotel.
  • The schedule for increases in program fees and other costs.
  • The ability of the franchisee or its affiliates to operate independent, potentially competing hotels.
  • The franchisee’s right to use telecommunication, management and other systems not supplied by or for the franchisor.
  • Limitations on the franchisor’s audit rights.
  • Reduction of liquidated damages on termination.
Negotiating the best franchise agreement, and creating the best franchise context for a successful relationship, requires a cooperative effort from the franchisor, franchisee, and counsel. JMBM has been involved in the negotiation of a variety of hotel franchise agreements with virtually every major franchisor and can assist in creating the greatest value in the franchise relationship.


Robert Braun is a senior member of JMBM’s Global Hospitality Group and a partner in the Corporate Department. Robert represents hospitality industry clients in both transactional and operational issues, including acquisitions and divestitures; joint ventures and strategic relationships; negotiating, implementing and monitoring hotel and resort management and franchise agreements; technology licenses; and compliance with internet and privacy obligations. You can reach Robert Braun at 310.785.5331 or at rbraun@jmbm.com.

The Global Hospitality Group® is a registered trademark of Jeffer, Mangels, Butler & Marmaro LLP

©2004 Jeffer, Mangels, Butler & Marmaro LLP

###


For more information:
Jeffer, Mangels, Butler & Marmaro LLP
web site: http://www.jmbm.com
Email Jim Butler at jbutler@jmbm.com
Or contact 
Jim Butler at the Firm
 Jeffer, Mangels, Butler & Marmaro LLP
  1900 Avenue of the Stars
 Los Angeles, CA 90067
     Phone: 310-201-3526 
The premier hospitality practice
in a full-service law firm
 --
Also See: ADA Lawsuit Alert: Beware the Internet Surf-by; A new twist on the ADA drive-by lawsuit / JMBM / September 2004
Hotel Unions Challenging Work Rules Found in Hotel Employer / The Global Hospitality Advisor Handbooks; Claim Interference with Employees’ Rights to Organize / JMBM / October 2003
Wage and Hour Lawsuits and Audits Continue to Sweep the Hospitality Industry / The Global Hospitality Advisor / JMBM / October 2003
Prepare NOW for an ADA Attack; Myths and Tips on How to Minimize Exposure / The Global Hospitality Advisor / JMBM / October 2003
Sarbanes-Oxley Update / The Global Hospitality Advisor / JMBM / Arpil 2003
Equal Public Access or Access to Deep Pockets? The Hospitality Industry Remains a Target of Lawsuits by Disability Rights Groups Under the Americans with Disabilities Act / The Global Hospitality Advisor / JMBM / March 2003
Outlook 2003: A Roundtable Discussion / The Global Hospitality Advisor / JMBM / Dec 2002 
Time Bomb Waiting to Explode: Wage & hour Claims Over Exempt Employees / The Global Hospitality Advisor / JMBM / Oct 2002
I'm Mad as Hell, and I'm Not Going to Take it Anymore! / The Global Hospitality Advisor / JMBM / Oct 2002
Settlement Procedure Available to California Hotels Plagued by Prop 65 Cases - The Global Hospitality Advisor / April  2002 
Top Ten Investment Challenges Facing the Lodging Industry / Lodging Industry Investment Council / April 2002 
Decertifying a Union? The Employer’s Bill of Rights / The Global Hospitality Advisor / JMBM / April 2002 
Outlook 2002: A Roundtable Discussion /  Bruce Baltin, Bjorn Hanson, Randy Smith, Jack Westergom - The Global Hospitality Advisor / January 2002 
New Rules for Hotel Workouts: REMICs for Dummies / The Global Hospitality Advisor / JMBM / December 2001 
Living in the Wake: Predictions & Practical Implications / The Global Hospitality Advisor / JMBM / December 2001 
Avoiding Liability for Lay-Offs / The Global Hospitality Advisor / December 2001
The Worker Adustment and Retraining Notification Act: Impact on the Hotel Industry / JMBM 
When is an Apartment a Hotel ... and Who Cares? / The Global Hospitality Advisor / JMBM / September 2001 
The 'Perfect Storm' / The Global Hospitality Advisor / JMBM / September 2001 
Richard Kessler's Grand Theme Hotels - Interview with GHG Chairman  Jim Butler / March 2001
Stephen Rushmore's  Industry Trends / Top Markets, Predictions & Opportunities  / Jan 2001
Outlook 2001: A Roundtable Discussion The Global Hospitality Advisor / Jan 2001
Perspectives on Hotel Financing in 2001; Jim Butler, JMBM's Global Hospitality Group Chairman, Interviews Two Active Players in Hotel Finance / Jan 2001 
Robert J. Morse: Millennium’s New President / Interview with GHG Chairman Jim Butler / Nov 2000 
Special Reports / Jeffer, Mangels, Butler & Marmaro LLP

To search Hotel Online data base of News and Trends Go to Hotel.Online Search
Back to Hotel.Online Press Releases
Home | Welcome! | Hospitality News | Classifieds | Catalogs & Pricing | Viewpoint Forum | Ideas/Trends
Please contact Hotel.Online with your comments and suggestions.