Attorney Michael Smith shared some key factors owners and asset managers should keep in mind when negotiating franchise and management agreements.
LEESBURG, Virginia—Franchise and management agreements are among the most fundamental pieces of the hotel business, and the favorability of those agreements can go a long way in determining success for a hotel owner or asset manager.
Speaking at the recent spring meeting of the Hospitality Asset Managers Association, Michael Smith, a partner at Brewer Attorneys & Counselors, said the terms of those agreements often decide the “winners and losers” during a market downturn.
To that end, Smith shared some of the key factors to consider when negotiating or renegotiating those deals.
1. Design deals to preserve cash flow
Smith noted that if there is one common trait among the downturn “losers,” it’s that they find themselves in a distressed situation, forced to sell off at a loss. To avoid this scenario, owners should go into negotiations looking to preserve cash flow wherever possible and implement “provisions that allow for aggressive management.”
“You want the ability to require cash reserves and plan for cash reserves,” he said.
He said it’s also important to have clear performance metrics and benchmarks included in deals.
2. Require transparency
Also common among underperforming hotels, Smith said, is a lack of scrutiny and clarity. He said owners and and asset managers need to push for transparency to get a better idea of how a property is doing before it reaches crisis levels.
“Sometimes you’ll find (numbers) that are squishy or false or inaccurate,” he said. “You need to make sure you have rights related to transparency and that owners preserve their right to actively participate in the management of the hotel.”
He said problems can arise from agreements that give managers “absolute and exclusive rights.”
3. Protect your geography
With franchise agreements, provisions on areas of exclusivity are a hot-button issue in this era of hotel brand consolidation, Smith said.
“This comes in to play in particular with acquisitions and megamergers when all of a sudden a competitor is managed by the same manager with the same reservations system,” he said.
It’s incumbent on owners and asset managers to go over that part of their deals with a fine-tooth comb to determine how broad their protections are and how they factor into their projected performance, he said.
4. Know what’s truly negotiable
Smith noted it can sometimes be difficult to push for concessions in franchise agreements because much of the language is uniform and boilerplate across the hotel industry. That said, he added, it’s a good idea to push when it comes to royalty fees and territorial restrictions, though concessions even in those areas can be “difficult to obtain and are fairly limited if accomplished.”
“Ultimately, a franchisor will have few obligations as long as they provide centralized services and licenses to their intellectual property,” he said. “So there’s not a whole lot left (to negotiate), and as a result of that, (owners) have a fairly limited ability to terminate franchise agreements.”
5. Being able to fire a manager is key
It’s important to outline exactly how and when an owner can fire a third-party manager if needed, as a measure to protect asset value and the investment in case of a downturn, Smith said. An owner’s ability to terminate a manager has strong case law backing it up, but it’s important to craft deals in a way that maintains that right, he added.
Once again, establishing tracking metrics is important, in case an owner has to prove underperformance or mismanagement, he said.
“Financial disclosure is key,” he said. “Numbers tell the story.”