International: What do owners and operators have to think about for new management agreements?

In brief

With the hospitality industry continuing to recover from the pandemic, hoteliers will want to capitalise on new opportunities for their hotels as new feeder markets continue to open up and more tourists embark on the region. The hotel management agreement is the most common form of agreement governing the relationship between the owner and the hotel manager/operator and consideration should be given to the terms of the agreement in light of the lessons learnt from the pandemic. In this article we look at the top 10 issues for hoteliers to consider as they enter into new hotel management agreements or look to renegotiate the terms of their current agreements in this new climate.

What should parties be thinking about?

Brand standard compliance
With the needs of guests ever changing (particularly in a post Covid-19 world), the parties may wish to discuss whether the operator should be permitted to rebrand the hotel during the term of the management agreement to suit consumer needs. Operators may wish to consider how critical brand compliance is and whether any allowances can be given to owners if brand standards are varied during the term.

Hotel employees are at the heart of the guest experience and are the cornerstone of the hospitality industry. The mass layoff, furlough or leave without pay arrangements that were implemented across the industry during the pandemic placed this core element of the hotel at risk. Better strategies need to be adopted and agreed between the parties to address the issue of staff retention in difficult circumstances where business activity suddenly comes to an end. The long term effects of these mass layoffs have yet to be felt but will no doubt have long reaching repercussions for the industry as a whole.

Working capital
The impact of Covid-19 of the hotel industry has highlighted the importance of working capital reserves. While the trend has been to reduce these reserves to the minimum amount possible, the pandemic exemplified the need for sufficient working capital reserves to be maintained for periods long enough to either (i) allow a force majeure event to subside and business to resume; or (ii) allow the hotel owner sufficient time to make a claim under its business interruption policy and receive the proceeds of insurance.

Guest data
With a number of hotels in the region being rebranded, the parties may wish to consider how important it is for the owner to access hotel guest data once the operator has ‘de-flagged’ and departed from the hotel.

Debt financing
As hotel valuations declined during the pandemic, loan to value ratio recalculations were triggered. Parties should ensure that any financing agreements suitably protect their needs in challenging conditions, such as having the ability to reschedule debt and alternative security packages.

The policy working of hotel owner’s property all risk insurance, and in particular, the business interruption component of that policy need to be carefully considered. The policy wording needs to respond in circumstances that go beyond physical damage to the hotel, so as to capture pandemic type circumstances where the hotel remains physically intact but the hotel business collapses for an extended period of time.

Force majeure
The concept of force majeure derives from the French civil law system and is frequently incorporated into commercial contracts that are governed by common law systems due to the limited remedies otherwise available to the contracting parties when the contract becomes either impossible, difficult or onerous to perform due to events outside the affected party’s control.

Often parties will debate whether the definition of a ‘force majeure event’ in a management agreement should be wide enough to cover global epidemics, pandemics, disease related events and travel disruption. Owners will often argue that these events should be limited to the country within which the hotel is located.

Some management agreements will afford both the owner and the operator the right to terminate if an event of force majeure persists for an extended period of time. This right of termination may become importation where closure of the hotel is warranted and the timeframe for its reopening is unclear or unlikely.

Covid-19 specific clause
Parties may wish to include a ‘pandemic specific’ clause as some feeder markets continue to face periods of lockdown due to Covid-19. The clause may enable a party to renegotiate fees if certain occupancy thresholds cannot be met due to a reduction in tourists which is directly related to feeder markets that are in lockdown.

Performance tests
Typically, where an agreement includes a performance test, there will be an obligation on the operator to ensure that: (a) the RevPAR meets the pre-agreed percentage of the average RevPAR of a group of competitive hotels within a certain distance of the hotel (often known as the competitive set); and (b) the operating profit of the hotel is no less than a pre-agreed percentage of the forecasted gross operating profit set out in the budget.

However, a ‘carve out’ is typically argued by the operator, so that they are not required to achieve the requirements of the performance test in the event of a ‘force majeure’. The parties may consider including a Covid specific ‘carve out’ where the operator is unable to meet its obligation due to the pandemic and certain feeder markets still not being re-opened into the region. This could be linked to the Covid-19 specific clause.

Governing law and dispute resolution
It is also important to consider the governing law clause when negotiating the management agreement as this will have an impact on how the provisions of the agreement are to be interpreted, particularly whether a pandemic or other unanticipated event can be classified as force majeure.

The forum for any disputes should be considered carefully between the parties as not only will this have a direct impact on costs, but it will be an important strategic consideration for both.

This article was originally published in the 8 June 2021 edition of Hotelier Middle East and is reproduced with permission.  The original article can be found here

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