Owners or operators: Who has upper hand in indemnity?
Owners or operators: Who has upper hand in indemnity?
17 APRIL 2017 8:17 AM

While contract clauses and insurance are necessary to protect hotel interests, these legal issues have evolved with the emergence of more sophisticated ownership groups. 

GLOBAL REPORT—More sophisticated ownership and increasingly flexible third-party managers are changing the landscape of indemnity agreements with the hotel industry international, according to sources.

All parties in a hotel business agreement should have clauses in place defending against liability/indemnity insurance claims and make restitution for costs and compensation resulting from legal cases, sources said, and all sides should be insured, too.

Almost every contract contains an indemnity clause, obligating a defaulting party to “hold harmless” the non-defaulting party, sources said. That means, in short, if one party is injured monetarily by the default or wrongdoing of the other party, the latter party must make the former whole. This normally includes covering attorney fees and other costs associated with enforcing the claim. Historically, these agreements have largely worked to the benefit of third party managers.

“Operators want owners to deem them not negligent, and owners usually agree to that,” said Kristina Fischer, associate VP of business development and legal services for Centara Hotels & Resorts.

But sources said owners have been carving out more exceptions and in some cases using them to create some protections for themselves, noting the traditional model created an obvious disconnect due to the fact that an operator—responsible for employment and day-to-day management—can step aside from liabilities, whereas the owner assumes final responsibility.

Subtle changes
With large sums of money potentially and important business relationships involved, the indemnity liability landscape is slowly changing to benefit both sides, sources said.

“In the days when there were just a handful of international management companies, and when owners were less sophisticated, this one-way …indemnification arrangement was common,” said Michael Evanoff, a lawyer and chairman of Marlborough Hospitality Services.

He added that the state of affairs then was “patently unfair.”

“Owners started to push back, and new entrants to the hotel management industry proved to be more flexible,” Evanoff said. “Accordingly, in the past 10 years or so, due to pressure from more sophisticated owners and from competitive forces, there has been increasing balance in indemnification provisions. Now it is usual for indemnification clauses to exclude situations where the management company was guilty of ‘gross negligence’ or ‘willful misconduct.’ Also, in cases where the management company is in fact guilty of gross negligence or willful misconduct, most agreements today require that the management company must indemnify the owner.”

Evanoff said the new arrangement isn’t as fair as it could be.

“The management company is operating the hotel and should, in theory, be fully responsible for any negligence or misconduct of the hotel’s employees, (although) unfairness is largely mitigated by insurance arrangements that are put in place,” he said.

The question often centers on the issue of whether the operator is an agent of the owner.

“Old management agreements stated the management company was merely the agent of the owner, again to distance itself from liability,” Evanoff said. “However, a long string of U.S. and other common-law courts have ruled that if the management company is merely the agent of the owner, the management agreement can be terminated at any time for any reason, as this is a core principle of agency law.”

He added damages might be payable.

“This by no means absolves the management company from liability,” Evanoff said.

Sources added owners often feel pinched.

“Owners still must have insurance, which is the first step … and we think the owner should bear that risk unless it can be shown it is the operator’s fault,” Fischer said.

Risk-reward dynamic
Operators believe they are not being rewarded sufficiently to accept liability, sources said, and the costs must be shared by both owners and operators

Selim Zein, VP of hospitality at Deyaar Development, said liability must be shared by both owners and operators.

“We expect some sharing of risk and responsibility,” Zein said. “Owners do not get to choose staff, for example, except for maybe one or two key personnel. One of the carve-outs owners would like in indemnity clauses regards gross negligence, and issues around data protection are of huge interest to us in terms of who is responsible.”

Evanoff said it is “usual for all of the hotel’s employees to be the employees of the owner, and not of the management company. … This is because all operating expenses, including salaries and wages, are paid from the revenue of the hotel, revenue that belongs to the owner, not the management company.”

Sources said in order to shift more responsibility to the management company, perhaps the cost of liability insurance should be split more evenly, but this would be very difficult to achieve by an owner in negotiations. If a management company were to pay more, it would probably be reflected in its demand to command a bigger fee.

Evanoff said another related issue is management companies that operate internationally often try to avoid setting up a “permanent establishment” in a foreign country, which might trigger additional taxes and would decrease the distance between a negligent employee and the management company.

Despite this, “the management company generally requires that it be in almost complete control of operations,” Evanoff said. “In a vacuum, this should mean that the management company is responsible for injuries to persons or property as a result of negligence or misconduct by the hotel’s employees.”

Liability might be further complicated by the fact a “chain-managed hotel is actually operated by the GM and the executive team assigned to the hotel, with no day-to-day involvement by the management company, even though the management agreement implies otherwise,” Evanoff said.

“Major decisions may need to be made ‘upstairs,’ but the management companies give great authority to their GMs and executive team members,” he said. “Nonetheless, having bargained for the right to have full ‘control and discretion’ in the operation of the hotel, the management companies cannot then point to the GM or executive team members if something goes wrong.”

Insure yourself, check out staff
Nassif BouMalhab, partner at law firm Clyde & Company, said first claims for damages should always be sent to the relevant insurer, but if an argument arises, indemnity clauses will be involved.

“Yes, owners argue that responsibility should be shared, but we also accept where the owner would say it was unfair for the management to accept responsibility on its own,” BouMalhab said. “On principle, there should be some indemnity clause present, and then we’ll look at the insurer, followed by carve-outs. There is a great difference in how terms are considered, and that does change in different jurisdictions. Also, it is very useful to define what gross negligence is.”

Fischer said there are very clear cases as to what defines gross negligence in some jurisdictions. She said companies should put additional safeguards in place, including implementing staff operating procedures and criminal background checks.

“To what extent is the manager willing to accept responsibility, and can that responsibility flow down to employees if (the alleged injury) can be seen to be a breach of policy?” BouMalhab said.

Hotel management companies might like to see more of a divide between themselves as the operator and its staff.

“The actions of employees are not the actions of the operator,” Fischer said.

BouMalhab said liability will inevitably arise due to the high number of occasions of employee interaction and thus it might not be reasonable to exempt operators from all negligence.

“What is the threshold? Operators have to have reasonable, standard operating procedures and staff training,” he said.

Sources said one area in which an indemnity clause might have real teeth is when funds are fraudulently siphoned away from the hotel by an employee, which is rare but not unheard of. While most hotels have fidelity insurance, this is clearly the management company’s responsibility, and the owner might want compensation from the management company beyond what the insurers will pay.

Regional differences and termination
The location of a hotel can add further red tape, sources said.

“Operators in Europe do factor in risks when it comes to fees, and risk is higher in the Middle East as it is a less-mature market, although still less than in the U.S., which is more litigious in general,” Zein said.

Evanoff added most management companies, at least the larger ones, arrange for umbrella insurance covering all hotels in the portfolio.

“If the hotel’s local insurance does not fully cover a claim, the umbrella policy will kick in,” he said. “Thus, it is rare for either an owner or a management company to pay a claim from its own pocket, aside from any deductible. A claim would need to be very large indeed to exceed the two layers of insurance covering the hotel.”

Evanoff added the ultimate weapon an owner could wield against a management company is the right of termination.

“As further protection against gross, or continuing, negligence or willful, or continuing, misconduct by the management company, such behavior can be made a specific event of default,” he said. “Arguably gross, or continuing, negligence, or willful, or continuing, misconduct would be a breach of the management company’s implied duty of care and therefore a breach of contract in any event.

“There is no downside to being explicit.”

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