Fueling hotel expansion with management agreements
 
Fueling hotel expansion with management agreements
27 JUNE 2018 7:48 AM

There are ways to leverage licensing and management agreements to maximize your hotel brand’s exposure and channels of revenue, all the while minimizing investment and financial exposure.

Your hospitality brand has real cachet.

It’s recognized worldwide, and demand at your hotel and resort properties—both domestically and overseas—is through the roof. No wonder you want to seize upon your hard-earned popularity and add locations to continue the measured expansion of your global footprint. Still, the capital outlays required for real estate acquisition and construction is neither feasible nor built into your long-term business plan, not to mention the risk and operating costs associated with property ownership.

Sound familiar? Do you find yourself—all at once—hoping to minimize investment and risk while seeking opportunity to maximize brand exposure and channels of revenue? If so, what’s a forward-thinking, growth-oriented hotelier like you to do? Consider this: licensing and hotel management agreements, both commonly used in tandem to facilitate expansion in the hospitality space. Indeed, for those searching for a lower-risk approach to increased brand reach, the following elements of licensing and hotel management deals should be front of mind.

The basics
Hospitality companies routinely go into business with financial partners who pay for, build and own projects that bear the names and signature styles of the companies’ established brands.

Typically, a hotelier will agree to license its trade name and associated intellectual property to a hotel facility and manage its operations in exchange for, among other things, the owner’s financial commitment to develop, hold, maintain and be responsible for the real estate. Such an arrangement is memorialized in a hotel management agreement between the financial partner (the owner) and the hotelier (the operator). Of note, these days it’s become business as usual for a hotel or resort project to include not only guestrooms, but also apartments for both permanent and transient residents. An HMA can contemplate such a setup, with residential units managed in a pool by the operator.

If you’re a hotelier looking to engage an owner to penetrate a new market by way of an HMA, the No. 1 priority must be the protection of your brand and economic interests. To safeguard your valuable assets, it’s of paramount importance to incorporate certain critical language into the agreement.

Protecting your brand
The unauthorized use of an operator’s trade name, trademarks or other IP is an area of real concern. To protect against such unauthorized use, an HMA must include unambiguous and robust license provisions that, at the very least, restrict the use of your IP to the hotel or resort complex subject to the agreement. Likewise, its best that the term of any license granted be in lockstep with the term of the HMA (translation: if the HMA is terminated early, so is the license).

And to the extent the HMA is a vehicle for international expansion, you’re encouraged to be on notice of all relevant rules regarding the ownership of IP, which may differ by country. In some, for example, an owner may be deemed to be the sole “user” of a trade name it licenses, as opposed to the operator who actually owns the IP and manages the property. Because failure to “use” IP can, in places, result in the loss of ownership rights, local registration may be advisable. Whatever the case may be, you must pay attention to all existing and potential issues related to IP and its permissible uses.

The second category of risk relates to damage to brand reputation. No doubt, your brand’s standing and status are among your biggest assets, which means that before allowing an owner to license your trade name or other IP, you need to make certain that the owner’s use will be consistent with the standards of design and quality associated with your brand across all markets. But how can you ensure this? The HMA, which should include provisions that hit upon all of the following:

  • the operator’s final approval over building design, finish, fixed features and equipment—all to assure consistency with the brand and its image;
  • payment by the owner of capital expenditures and adequate maintenance costs that will allow for the property’s continued compliance with brand standards (this should also contemplate the owner’s periodic replacement of fixtures, equipment, décor, furnishings and the like);
  • the operator’s exclusive control of all hotel operations, which is meant to guarantee that brand standards (including service) are met; and
  • matters regarding damage and loss; specifically, appropriate insurance coverage and the promise that the operator will have the freedom and capacity to quickly make repairs and replace furnishings (at the owner’s expense regardless of insurance recovery).

Protecting your economic interests
One of the driving forces behind a decision to pursue an HMA is dollars and cents. Clearly, what might make an HMA attractive to you and your hospitality brand is no secret—as a licensor and operator, an HMA allows you to circumvent the financial burdens associated with hotel ownership. To be sure, given that company economics may dictate your strategic planning and growth trajectory, and because you should not shoulder the economic risk of an unprofitable project, protection of your economic interests must be properly addressed in any HMA you enter.

Toward that end, language in the agreement can provide that your costs as the operator are fully recovered by gross revenue, that the operator—as the point of contact with customers—has full control of that revenue stream, and that the costs of operation are paid before the owner is granted access to cash flow. In addition, by way of the HMA, the owner should agree to fairly compensate you for shared services delivered brandwide—like advertising, centralized reservations and accounting. And of course, ironclad indemnification terms are strongly recommended.

Without question, the four corners of the HMA can help to shield you from financial peril at the hands of an owner. At the same time, there are matters outside the agreement that also require your focus should you function as an operator.

Operators beware: Potential pitfalls and liability traps
There’s no denying the benefits you can reap by expanding your brand through an HMA. Nevertheless, as with any business relationship, such a venture presents possible downsides and avenues for liability. One involves the burden of employees.

No surprise, the pitfalls of being an employer are many, with legal exposure to employees a constant worry. It’s important for operators to ascertain exactly who in the owner/operator paradigm will be on the hook to hotel workers for minimum wage, overtime, health and safety, and compliance with other applicable employment laws. In the U.S., employer status generally depends upon which party directs employees—in the case of a hospitality company managing a hotel facility, the operator. Nonetheless, in some jurisdictions outside the U.S., an owner can be deemed to be the employer, an obvious advantage to an operator that actually controls workers and runs payroll.

Taxes can be problematic, too; namely, value-added taxes (VAT), which are a mystery to many an operator. Depending on the jurisdiction, VAT may apply to an array of transactions, including management fees, incentive bonuses and reimbursement of costs. Consequently, operators must be sure that the cost of VAT is computed into the cash flows of a project, and that they’re sufficiently compensated, net of VAT, to cover costs and provide desired returns.

Property taxes and similar payments can sometimes be a sticking point as well. While they’re generally the owner’s obligation, operators need the ability to pay them in the first instance or in the event the owner fails to do so, with the right of reimbursement. This is also true of various fees that some locales (here and abroad) might impose to cover tourist promotions, area events, security and so forth.

Finally, an operator entering an HMA must choose the governing law and venue for dispute resolution wisely. Particularly for overseas projects, local law can present obstacles to recovery, equitable relief and indemnification rights, and local courts might not always be reliable.

The takeaway
Despite these, and other potential stumbling blocks, you can certainly fuel the expansion of your hotel or resort brand cost-effectively by way of a well-negotiated HMA—an HMA that underscores the protection of your IP, brand reputation and economic interests.

Eric Simonson is a partner of Michelman & Robinson, LLP, a national law firm with offices in Los Angeles, Orange County (California), San Francisco, Chicago and New York City. He is a corporate lawyer who provides advice and counsel to companies, both privately held and publically traded and including those in the hospitality space, in a range of matters. Mr. Simonson can be contacted at esimonson@mrllp.com or 212-730-7700.

Diyari Vázquez is counsel at M&R, where she represents clients in the hospitality industry, and advises them in matters related to labor and employment law, including discrimination, harassment, wrongful termination, reduction in workforce, hiring, wage and hour issues, and the like. She can be contacted at 310-564-2670 or dvazquez@mrllp.com.

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