The changing dynamics of hotel management agreements
 
The changing dynamics of hotel management agreements
02 FEBRUARY 2017 8:47 AM

Owners are becoming far more savvy about hotel management agreements, but they face the same challenges of finding the right partnership and managing costs when an asset goes wrong. 

GLOBAL REPORT—Owners are becoming more likely to push back against operators over hotel management agreements, according to sources, who added there are geographical differences in how this relationship plays out.

Sources stressed the best scenario is when owners and operators are working in partnership, with the right contract clauses in place from the beginning, but both sides always have a responsibility to protect their interests. Terminating a management contract remains a fraught exercise, sources said, with care needed over negotiations and wording.

HMAs are no longer the most dominant form of hotel contract in terms of the number of properties they cover, but they are in terms of the value of the assets they cover, sources said.

Jim Butler, partner and chairman of the global hospitality group at Jeffer Mangels Butler & Mitchell, said that 20 or 30 years ago HMAs accounted for approximately 80% of branded hotels, but that has changed in the U.S.

“Now the situation is reversed, and approximately 80% of all branded hotels today operate under franchise agreements, with only 20% using the HMA format,” he said. “However, the HMA is typically used for larger, strategically important, upscale and luxury properties, so by dollar value, HMAs may still govern a majority of hotels as measured by their value, as opposed to sheer numbers.”

Douglas Wignall, a United Kingdom lawyer at Cubism Law, said Europe has different considerations because there are fewer branded hotels.

When HMAs were introduced into the U.K. in the 1980s, he said, only a very small portion of hotels had them, with most being luxury hotels in London. But things are changing on that side of the Atlantic, too.

“Operators have expanded via HMAs, although it is very difficult to get a HMA in Germany, where all financing is geared to leases,” Wignall said. “Vendors in Europe have preferred leases with fixed returns,”

Operators are at the sharp end of this change, according to Stewart Campbell, managing director of Glasgow-based hotel management company Redefine|BDL.

“There has been fundamentally a big change in the market in the U.K., and that is now occurring in Europe, away from HMAs in their entirety,” Campbell said. “Franchising is where things are. We speak to a lot of the big brands, about pipeline, and what they are always talking about is how much is franchised and leased. Only AccorHotels owns.

“Owners see franchises as excellent when it comes to exiting, as they have more flexibility in terms of termination. They make the hotel asset more liquid. Unencumbered properties do not happen often, only when there has been a fallout. (Managed and franchised properties) can be a good compromise.”

Owners to the fore
Butler said the goal of a branded management company is to have long-term, no-cut contracts that provide a valuable series of cash flows. Any contractual provisions or legal rights that might be used by an owner to terminate the contract are undesirable, he said.

Operators are “making it more difficult and expensive for owners to terminate for lack of performance, change in control, competition or other reasons,” Butler said.

But owners—who now include individuals, institutions and sovereign wealth firms—are getting wiser, he said.

Campbell said brands needed to position themselves closer to owners.

“Brands as yet have not (gotten) more flexible,” he said. “They are not very opaque and give as little as information as they can get away with. Historically, our industry has a terrible reputation of being too friendly to brands, and brands as operators have a lot of comeback with little risk.

“But the most important element will always be the owner. They have to see the impact, or they will go into different asset classes.”

Campbell added that unlike most brands, Redefine|BDL does not rely on legal contracts, which are only as good as the last P&L result.

Wignall agreed operators are being more flexible, especially in markets such as Asia. Flexibility is required in the current landscape, he said, with concerns over groups such as Airbnb, increases in franchising, and the rise in nonbranded hotels in the upscale and upper upscale-plus segments.

“HMAs are relatively novel in Europe, but today, operators are finding it more difficult to expand via HMAs as owners and developers become more used to them, as well as more canny and wary,” Wignall said.

He added that he recently has been involved in negotiations in which the operator offered a waiver of their fee on the condition that they failed to reach their predicted performance and, if there remained a shortfall, guaranteed a certain amount back off their own fee.

“Owners are also appointing asset managers,” Wignall said.

He said three European and Asian operators that he recently worked with proved they believed in their products by agreeing to very flexible contract clauses.

“Two were willing to accept a one-tier (termination) test, and one of them offered termination on sale after the first five years for two times the management (fee), and termination without cause in that same period for three times (the fee),” Wignall said. “That bodes well for their confidence in their brand, although Asians are not used to litigation.”

High potential expenses
Another reason for change is that HMAs have become more expensive in terms of generally higher base and incentive fees, and particularly the costs charged to owners.

Operators might like that. Owners do not.

“For the past decade, owners have been charged more money for services, and new services, which used to be free, are now charged to owners,” Butler said. “Also in the time period, the purchasing function performed by operators has tended to become a contractually approved profit source, as opposed to contracts used to prohibit any profit or markup on related party transactions and purchasing.”

Butler said things are a bit different in North America.

“In recent years, operators have successfully gotten owners to sign HMAs with reduced obligations on the part of the operator and fewer rights on the part of the owner,” he said. “Thus, hotels have less protection against competition (in duration, protected area, brands covered and exceptions), there are no performance standards or standards greatly watered down from those provided previously, and there are fewer contractual provisions enabling the owner to terminate upon specified events, such a sale or merger of the operator or a change in control.

“HMAs today tend to lack contractual termination provisions enabling owners to terminate for free, or even for a specified fee, on sale of the property or at will.”

He said recently it seems operators have given up fighting owners’ termination of HMAs over agency or personal service contract legalities.

“Thus, in some ways it is easier for an owner to terminate,” Butler said. “But the owner will be liable for substantial damages if the termination was wrongful—that is, without legal justification. The real trick is to know when to ask for what, and what tradeoffs might be acceptable to both parties. Owners working with hotel brands should get advisors who can provide this kind of business, legal and market input to make smart decisions.”

Generally the hotel industry remains a business where a handshake, not the pounding of a gavel, seals the deal, sources said.

“Perhaps the U.K. is becoming a little more litigious, but essentially agreements remain dealt with in a very gentlemanly way,” Campbell said. “The nightmare begins when owners cannot deal with the brand.”

Wignall agreed the U.K. might be a little more litigious than the rest of Europe, but he said he cannot recall any major litigation in the U.K., probably because negotiations usually are led by in-house lawyers, rather than operators’ development teams.

“The main point for owners to understand with an HMA, and this has not really changed, is that they are signing and giving away control of their asset for 25 or more years,” Wignall said. “Owners should view the typical operator-drafted template HMA as having three principles—no risk, no liability and nontermination—and start from that basis.”

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