The tips and traps

1. When should planning for a switch begin?

Planning for a switch should begin way back when the management agreement with the outgoing manager is being negotiated. Although there are some exceptions, the usual industry standard management agreements in currency today generally contain scant or no provisions to address the myriad of issues consequent upon the transition from the outgoing manager to the incoming manager.

The reasons for this are pretty clear. Management agreement negotiations are generally based upon templates prepared by the prospective operator and therefore it is understandable that the operator does not consider that it is necessary or beneficial to go into great detail about the circumstances of its contractual demise. Additionally owners, particularly new owners, generally do not turn their minds to this topic at the outset of the relationship.

In our view consideration should be given to the mechanics of such a transition with the intent that, as far as possible, there is a step by step procedure set out in the management agreement. It is beyond the scope of this newsletter to go into this in detail. However the following list will give the reader a flavor for the types of matters that consideration should be given to :-

• Protocols in relation to post transfer bookings and deposits
• Responsibility for transfer of business names, business licences and permits
• Preservation and handover of original documentation
• Content and timing of press releases in relation to the switch
• Handover of the financial data and guest information
• Timing for the payment of all fees owing to outgoing manager and the procedure to deal with any disputes
• Procedures regarding the use of outgoing manager's branded consumables and FF&E post switch
• Procedures and cost allocation relating to removal of outgoing operator's internal and external signage
• Transfer of telephone numbers and domain names
• Confidentiality provisions which may restrict the free flow of information with the incoming operator

2. What are the reasons why an owner contemplates a switch?

The primary reasons are as follows:-

• The owner is dissatisfied with the manager's performance and can terminate the management agreement pursuant to a performance termination provision or some other means.
• The management agreement term has expired and for whatever reason the owner wishes to try another manager.
• The owner wants to sell the hotel and use the termination on sale provision in the management agreement. They believe the hotel will fetch a higher price with vacant possession, or the preferred buyer's bid is conditional on it. The buyer may want to run the hotel itself, appoint a new manager, or franchise it.

3. Who should be involved

If the owner is inexperienced in relation to switching managers or more particularly has not dealt with either or both the outgoing manager and the incoming manager on a switch previously then it pays to engage a hotel consultant who has such experience.

The outgoing manager will usually act significantly differently in a situation where the dismissal is uncontested and not acrimonious as opposed to a situation where the dismissal has "left a bad taste in the (operator's) mouth". Experience with the operator in either situation can be highly beneficial in minimising the direct and indirect costs that such a dismissal can generate. The costs are the direct cost of the switch and the indirect cost regarding the impact on revenue and profit for any period that the hotel's management is "rudderless". The latter cost is less obvious than the former but can end up being many times larger.

Equally a lawyer with requisite experience can be invaluable to compliment the experience of the hotel consultant.

Like a bad divorce, the costs of a poorly handled dismissal can be eye watering.

4. Dealings with the outgoing operator

There are a number of strands to this topic and all need to be considered in great detail.

If the termination is planned to take place during the term of the management agreement by use of a performance termination provision, no fault termination provision or an actionable default on the operator's part, extreme care needs to be exercised to ensure that the action taken is completely consistent with the owner's rights under the management agreement.

If the owner issues a termination notice in circumstances which are not totally permitted by the strict terms of the management agreement then the operator can seek to argue that this constitutes a repudiation of the management agreement. Assuming that this argument is correct, the Manager would then be entitled to accept the owner's repudiation and terminate the agreement for owner breach and seek damages.

These damages can be very substantial generally calculated as the net present value of the prospective fee stream over the balance of the term of the management agreement less any allowance for fees that the manager would be able to secure which would not be available to the manager if the management agreement had run its course (usually because an area of restraint restriction binding the manager under the management agreement ceases to apply upon valid termination).

It is almost impossible to totally prescribe how an outgoing manager should be expected to conduct itself during the transitional period. An experienced hotel consultant in combination with an experienced lawyer should be able to predict with significant accuracy how any given operator will act.

The main aim is to ensure that the transition is as seamless as possible with the least leakage in hotel revenue and profitability and the minimisation of one off costs brought about by virtue of the transmission. It is obviously very important to keep the outgoing manager "on side". On some occasions this can be difficult especially if the outgoing manager is miffed about being terminated. The worst outcome is if the lines of communication between the owner and the outgoing manager completely break down. This is where timely intervention by the hotel consultant and lawyer can be invaluable.

5. Dealings with the incoming operator

After an owner has decided to terminate the relationship with the outgoing manager, the next item on the agenda should be a consideration of how the hotel should be managed post termination. Usually the choice comes down to the selection of another operator. An owner either can zero in on one candidate or establish an operator selection process. In our view the best outcome for an owner is a thoroughly thought through operator selection. We have discussed this topic in detail recently, here.

When a potential new operator is approached to pitch it would not be unsurprising for it to request an indemnity from the owner. The reason why a prospective incoming operator would require such legal protection is to insulate itself from any prospective actual or perceived legal action taken by the outgoing operator. The basis of any such legal action is based upon a legal doctrine called tortious interference. The indemnity is normally broadly drafted and obligates the owner to cover all legal costs incurred (including any damages award payable by the incoming operator) resulting from a claim by the outgoing operator. A detailed analysis of this doctrine is beyond the scope of this newsletter. Suffice to say whilst an owner may be required to provide an indemnity to induce one or more prospective incoming operators to engage in the selection process, the terms of the indemnity needs to be closely considered.

One further word, all too often in our experience owners have grossly under-estimated the time it takes to negotiate a legally binding management agreement with an incoming operator. Plenty of time should be allocated to this task. Operators of course are not as time sensitive as an owner and may seek to exploit this to their commercial advantage – which they are perfectly entitled to do.

6. Termination on sale – a further complication

Termination on sale adds a further layer of complexity to what is already a complex situation. Admittedly, the owner does not need to deal with the selection of an incoming operator. Instead, it needs to factor in the complexity introduced by a contract for the sale of the hotel, the termination of the existing operator such that it does not adversely affect the owner's timetable in relation to the sale agreement completion date and the quest to settle on a seamless transition of the outgoing manager's period of stewardship and the commencement of the purchaser's incoming manager's stewardship period.

7. A final comment

We have focused primarily on the situation where the switch is to an incoming manager. However generally the same issues and considerations apply where the owner elects to manage the hotel itself or to franchise. The detailed linkages and loose ends need to be addressed roughly to the same extent.

Conclusion

The practical reality is that most current management agreements are largely or completely silent on the switching procedure which means that the owner, the new owner, if any, and the incoming operator are reliant on the goodwill and sensible commercial approach of the outgoing operator. However, it is not clear whether this actually happens or whether significant issues do arise and none of the affected parties makes a noise about it for fear of making things worse.

Switching managers is one of those areas which receives little consideration in the literature. That is regrettable as if handled incorrectly or incompletely it can become a major disaster and damage the hotel's operating performance for a far longer period than most not familiar with this would consider.

A hotel which generates revenue and profit from a totally perishable service (i.e., tonight's hotel room availability if not sold will never be able to be sold again) needs strong and focused management each and every day of its operating life.