In depth

What does a franchise in the hotel industry entail as compared to a management agreement?

Hotel franchises are not particularly different from franchises in other industries such as the fast food industry where McDonald's would perhaps be a well-known example.

When a hotel management company offers to manage a hotel for an owner it generally provides the following services:-

• On the ground day-to-day management oversight;
• A well recognised and respected brand;
• Centralised services such as reservations and customer care  and
• Bespoke technical assistance on an as needed basis.

Under a franchise all these services are generally provided except for on the ground day to day management. This then leaves the hotel owner with the decision to either manage the hotel on a day to day basis itself or appoint a specialist white label hotel management company. Importantly, there would seem to be no hard and fast rules in relation to franchisors being required to comply with so-called "Area of Protection" restrictions whereas just about all hotel managers have restrictions imposed upon them not to operate a competing hotel within a specified radius of the subject hotel (subject to limited exclusions). This means that theoretically a hotel management company can offer more franchises in a given area than management agreements.

From the franchisors perspective, we also understand that even though a franchise does not generate the same revenue as a management agreement for a given property, it generates more profit. We also understand that the capital markets rate franchise income as more valuable than management income.

For completeness we also mention that in other newsletters we have focused on "manchises" which consists of a standard management agreement which generally contains a provision which allows the owner to elect to convert to a standard franchise agreement.

How do fees compare

In Australia today, according to our 2024 Asia Pacific Hotel Management Agreement survey undertaken with JLL, a manager under a management agreement is usually paid by a combination of base fees (generally in the 1%-1.5% of Gross Revenue range) and incentive fees (generally in the range of 6% - 7% of Gross Operating profit (and increasingly stepped on the basis that the percentage increases in proportion to GOP as a percentage of Gross Revenue). Other fees may include a technical services fee and various centralised services fees (including marketing, reservations and loyalty programmes).

Franchisors typically charge a brand royalty fees (usually around 2-4% of room revenue). Other fees can vary quite considerably between brands, and may include:- technical service fee; establishment fee; re-signing fee; training fees; transfer fee; transferee induction fee; franchise support fee; sales and marketing contribution; reservation fees; information technology fees and loyalty programme fees. Some brands operate a marketing fund or similar which all franchisees are required to contribute to, with funds used to promote the system as a whole.

Different operating companies in their capacity as managers and franchisors use different names to describe their fees, or slice and dice these fees differently which makes a comparison of such fees as between different proposed service providers very difficult. Further the more highly treasured the deal, the more managers and franchisors will wave or reduce one or more of their fee streams.

It is generally considered that it costs more to engage a manager than a franchisor. However that may change if, in addition to the franchisor, the owner engages a white label manager.

The Franchising Code of Conduct ("The Code")

In Australia, management agreements are unregulated.

Irrespective of the financial standing of the franchisee, hotel franchises are highly regulated under the Code and the requirements need to be clearly understood and followed otherwise the franchisor is potentially exposed to financial penalties for breaches. The Code is regulated by the Australian Competition and Consumer Commission (ACCC) which is active in this area.

The Code regulates the following aspects of the franchisor's dealings with prospective and existing franchisees and these requirements cannot be contracted out of by the parties:-

• Providing an "Information Statement" in the prescribed form and in the prescribed manner to a prospective franchisee;
• Providing a disclosure statement in the prescribed form to assist a franchisee to make a reasonably informed decision about the franchise, which must be updated on a yearly basis;
• Regulating the relationship with the franchisee:-
  • Duty to act with each other in good faith;
  • Franchisor must not unreasonably withhold consent to transfer;
  • Specific requirements around termination by the franchisor;
  • A prohibition on the franchisor requiring the franchisee to undertake significant capital expenditure during the franchise agreement (unless certain exceptions apply);
  • End of term obligations for the franchisor (including regarding the provision of notice);
  • Prescribed dispute resolution procedure;
  • Franchisor record keeping obligations;  
• Providing the franchisee with a 14-day cooling off period when a franchise is entered into;
• Registration of the franchise on the national Franchise Disclosure Register.

Tricky situations that can arise include the following:

• Where a hotel franchisee seeks to sell a hotel in conjunction with the assignment of an existing franchise agreement.

The incoming franchisee/purchaser has a 14-day cooling off period which cannot be contracted out of. Should the incoming franchisee/purchaser seek to exercise its termination rights during the cooling off period, the Code is unhelpful as to the true impact of the exercise of these rights. Does it simply mean that the franchise agreement is terminated? There is wording in the Code which may suggest that the exercise of the cooling off rights may trigger a reversion of the franchise back to the previous franchisee and if this is the case what is the fate of the hotel – does it need to revert as well and if so how is this achieved?

There is currently no guidance as to how this potential "train crash" scenario can be satisfactorily dealt with in practice. In our view it is only a matter of time before a purchaser exercises its cooling off rights. We suspect that when this occurs only the lawyers will benefit.

Our strong suggestion is that this potentiality is best considered at the time that the original franchise is being negotiated rather than the time that the hotel is being put up for sale or when the cooling off rights are exercised.

• Where a franchisor requires Australian franchisees to make payments into an internationally administered marketing fund.

The Code sets out detailed requirements for marketing funds or other cooperative funds to which franchisees are to make payments. These include preparing an annual financial statement and having it audited. In addition, the ACCC has a particular focus on the details required for the financial statement, and has brought a number of cases against franchisors in this area. International franchisors can find the Australian requirements difficult to comply with.

The penalties for breach of the Code can be substantial:-

• Up to AUD 198,000 per breach of certain requirements;
• Super penalties apply for breach of ongoing disclose requirements, being the greater of:-
  • AUD 10 Million;
  • Three times the value of the benefit obtained directly or indirectly from the contravention; and
  • If the value cannot be determined, 10% of annual turnover during the preceding 12 month period

Recent amendments to the Code come into effect on 1 April 2025 and will apply to franchise agreements entered into transferred, renewed or extended on or after that date (with certain exceptions). The new Code contains a number of important changes including a requirement for the franchisor to include provisions in the franchise agreement dealing with compensation for the franchisee if the agreement is terminated early because the franchisor withdraws from the Australian market, rationalises its Australian network or changes its Australian distribution model, and a prohibition on certain types of post-term restraints of trade. The number of provisions to which penalties apply has also been expanded. See our Client Alert on 13 December 2024, here, for further details.

There is also a prospect that further legislation will be introduced to require franchisors to licensed.

Conclusion

It is debatable whether hotel franchisees which are usually very substantial corporate entities should be entitled to the benefit of the protections provided by the Code. Be that as it may, the Code applies to protect all franchisees including the big guys. Whilst the Code imposes an additional layer of cost and regulation on hotel franchisors it doesn't seem to be the case that this is in any way impeding the expansion of hotel franchises in Australia.