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Terminating Hotel Management Agreements
When Things Don't Work

Not Easy, But Not Impossible Either
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by Jim Butler, June 2009 

What is one of the nicest acknowledgements of professional accomplishment a hotel lawyer might receive? In my book, being recognized by the New York Times as an expert in a core aspect of my legal and advisory practice is pretty close, and that is what happened yesterday in a Times article by Jonathan D. Glater about the increased friction between hotel owners and operators now erupting into litigation in the case of the Four Seasons Aviara and the Fairmont Turnberry.

As I said in another New York Times quote last month by Martha C. White, we are facing the prospect of hotel bankruptcies and foreclosures reaching levels not seen since the last big downturn of the 1990s.

And indeed, it is in difficult times like these when hotels fail to meet debt service -- or even operating expenses -- that owners and lenders become very frustrated with operators that prefer their own interests to those of the hotel. And that is why Jonathan Glater's article was looking at two high profile emerging battles where owners are standing up to operators and saying, "I'm mad as hell, and I'm not going to take it anymore."

Here's how we see it.

Hotel Management Agreement hell -- our perspective

Sometimes desperate owners prematurely jump to the conclusion that a hotel management agreement should be terminated. Without the correct analysis, this is like the old joke about "fire, ready, aim." Do your analysis first. But more about that in a moment.

Struggling to carry an underwater hotel with a bad operator and an onerous agreement is "management agreement hell." We know.

We started our Global Hospitality Group® practice, focused on hotel owners and lenders, more than 20 years ago. It seemed like anyone who knew anything about hotel management agreements was on the operator side, so we started helping lenders and owners terminate or renegotiate long-term, no-cut hotel management agreements that purported to run for 50 or 100 years. 

We have negotiated, re-negotiated, litigated or arbitrated and advised on many HUNDREDS of hotel management agreements -- more than 1,000. We understand how the contract relates to the operations of the hotel business associated with the real estate. We know the players, the norms and customs, and the practices of the industry. And our experience over many hundreds of management agreements helps us define and guide our client on what is "market" and an achievable result.

We have seen it all: 

  • Operators who insist on keeping 5 restaurants open 24 hours a day even though they are empty and losing a fortune. 
  • Overstaffed executive and line staff that inflate payrolls and sometimes are used to make your hotel a training ground or retirement center. 
  • Branded operators delivering only 5% of the hotel's business through its reservation and marketing systems. 
  • Operating standards that may maintain a brand image but don't contribute to profitability. 
  • Pricing rooms and services to maintain "rate leadership" in a market for the brand's perceived position, instead of getting a fair share of the available business for the hotel.
Does this sound familiar? Operators that are ineffective or fail to respond to critical needs

Most owners become very frustrated when they feel that their operator is not responding to a critical situation. The aggravation level escalates when the operator isn't proactive to drive business, cut costs and better manage capital expenditure issues. Sometimes the operators seem to tell you anything they think you want to hear -- month after month -- but do nothing, despite repeated promises. Whatever the reasons, bad financial results can severely wound owners and lenders who feel they are entitled to expect results from operators who proclaim their expertise and take their money "off the top" -- as a percentage of gross revenues, or through markups, purchasing fees, reservation fees, frequent traveler charges, and the like. They are dismayed when the operator is unable or ineffectual at getting results.

The operators run your hotel, hire and fire your employees, set the pricing and standards, and tell you when they want you to write checks to upgrade the carpet and pool furniture, make payroll or pay their fees. 

That is the background that led to my quote in the New York Times article about how hotel management agreements structure the relationship of owner and operator:

"It gives the operators all the benefits of ownership with none of the burdens," said James R. Butler Jr., a lawyer at Jeffer Mangels Butler & Marmaro in Los Angeles. "It pushes to the owner all of the costs -- the capital costs of buying, maintaining and operating the property -- and lets the managing companies take most of their money off the top."
Why not just terminate a bad operator? What can you do?

Most branded hotel management agreements run for decades. They are not terminable at will nor just because the hotel is underperforming. And they usually have very tricky procedures requiring notice of perceived breach with an one or more opportunities for the operator to "cure" the default. So it is not usually easy to terminate a hotel management agreement. But if you terminate and do not have proper justification, you will be responsible for damages for breach of contract, which could amount to the present value of the income stream the operator would have received for the remainder of the contract term. This could be very expensive. 

Of course there are other reasons not to terminate a hotel management agreement without due consideration. For example, although it may be convenient to blame the operator, a hotel's difficulties may not be the operator's fault at all. Even if an owner could terminate an agreement, it might not be the wisest thing to do. Maybe the present brand is the best brand and management for a property. The costs (and loss of momentum) of rebranding can be substantial. To do so if unnecessary would be very counterproductive. Besides, most brands will make a termination effort very expensive and time consuming unless they see it your way (and they probably won't without a lot of professional guidance).

When your hotel fails to perform, what should you do? The SAVE™ program 

When things are not going well at your hotel, the first thing you need to do is find out WHY they aren't going right. And that is exactly what we designed the SAVE™ program to do. SAVE stands for "Strategies and Approaches for Value Enhancement" for a hotel. 

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 deal with legal options. With lender encouragement, the goal is to help the owner/borrower to quickly develop a detailed plan and approach, gain lender approval for the plan, and then execute the plan with regular reporting and communications between the borrower and lender. 

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? Many operators are more responsive to owner requests in this environment. Is this the right operator or just difficult times for everyone? Has the operator breached either its express or its implied covenants under the hotel management agreement? Can the management agreement be terminated for any other reason, such as the fiduciary duty of the agency relationship created by almost all hotel management agreements? Is there some win-win for all parties other than termination?

About the Author:
Jim Butler is one of the top hotel lawyers in the world. GOOGLE “hotel lawyer” or “hotel mixed-use” or “condo hotel lawyer” and you will see why.  He devotes 100% of his practice to hospitality, representing hotel owners, developers and lenders.  Jim leads JMBM’s Global Hospitality Group®—a team of 50 seasoned professionals with more than $40 billion of hotel transactional experience, involving more than 1,000 properties located around the globe. In the last 5 years alone, they have brought their practical advice to more than 80 “hotel-enhanced mixed-use” projects, a term Jim coined to fill a void in industry lexicon.  This term describes one of the hottest developments in real estate-where hotels work together with shopping center, residential, office, retail, spa and sports facility components to mutually enhance the entire project’s excitement and success. 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. They are a major gateway of hotel finance, facilitating the flow of capital with their legal skill, hospitality industry knowledge and ability to find the right “fit” for all parts of the capital stack.  Because they are part of the very fabric of the hotel industry, they are able to help clients identify key business goals, assemble the right team, strategize the approach to optimize value and then get the deal done.  Jim is the author of the Hotel Law Blog, www.HotelLawBlog.com.  He can be reached at +1 310.201.3526 or jbutler@jmbm.com.

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Jim Butler
Chairman, Global Hospitality Group
Jeffer, Mangels, Butler & Marmaro LLP
1900 Avenue of the Stars, 7th Floor
Los Angeles, CA 90067-4308
(310) 201-3526 direct
jbutler@jmbm.com
www.HotelLawBlog.com
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Also See: Hotel Borrower Dilemma: the Note Is in Default or Coming Due; Helping Borrowers Create Value with Distressed Hotels / Jim Butler / April 2009
Terminating Hotel Management Agreements without Liability / Jim Butler / Arpil 2009
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