Guest Article: The Ugly World of Hotel Management Agreement Disputes – ICC

There is a growing trend of hotel owners attempting to terminate hotel management agreements signed with operators, sometimes referred to as operator agreements. With the 10th ICC MENA Conference on International Arbitration fast approaching, Sadique Mohd, Head of Arbitration at Al Aidarous Advocates and Legal Consultants, delved into the world of hotel management agreement litigation .

Disputes over hotel management (HA) agreements can be ugly. HAs are generally between 30 and 35 years old. The tendency of an owner is to appoint a reputable operator. This is usually combined with a trademark/license agreement to use the operator’s name or brand. Most owners are relative novices, or they cannot match the operator’s means on HAs. Owners also often approach HAs as a routine business deal. The owner usually ends up accepting the terms of the operator with some modifications to the key terms of the HA. It’s risky. HAs are often written by seasoned operators and loaded with latent time bombs that are not apparent to the owner until the owner sets sail with the operator.

In this context, the themes below come up regularly as important points of contention in arbitrations.

A workable termination clause

High availability is configured to make it nearly impossible for operators to terminate. Some landlords fail to solidly negotiate reasons for termination, leaving them locked into a long relationship. Owners are then paralyzed from terminating for fear of unlawful termination when substantial compensation would generally be owed by the owner to the operator.

Absence or absence of a performance test

Owners sometimes forget to include a performance test in high availability. This is the industry KPI for evaluating operator performance, violation of which allows the owner to terminate. Others agree to a low hanging performance test. Its absence means that a simple reason for terminating the operator is lost.

Using RevPar and TRevPar

Some owners and courts have a basic understanding of hotel profitability. The operator’s performance index is not revenue per se but RevPar (revenue per available room) or TRevPar (total revenue per available room). These are true indicators of a hotel’s profitability. It relates directly to operator performance and should be included as part of the performance test. It is also a useful evidentiary tool to objectively demonstrate an underperforming operator in court.

Management Fee Formula

There are cases where owners accept a management fee for the operator as a percentage of revenue rather than, say, gross operating profit. This means that the operator is paid for 30 to 35 years, regardless of the performance of the hotel. This usually becomes a pinch point for the landlord and invariably leads or contributes to a dispute.

Love relationship

Most conflicts arise because operators do not fully realize that not all owners are cut from the same cloth. Some owners are passive while others micromanage. The operator is akin to the proverbial driver driving the owner’s toddler in the car without the owner. It is wise to make the owners feel that they are participating in the same optical project. Warm relationships can smooth out the creases of a long relationship. Although HAs are difficult to terminate, from a reputational and cost perspective, most operators will not want an owner attempting to terminate the HA.

Agency with interest

A potential winning point for the operator to resist termination is having a stake in the hotel itself. This involves owning certain residential or commercial units in the hotel and registering that interest in the PA. This gives the trader doubled agency interest. This makes the HA almost endless. The expulsion of the operator becomes more complex and difficult.

Key points to remember

There is a First Commandment. Physical possession is the 10th/10th of the law. Shortly before and during the arbitration dispute, the operator must ensure that he is not physically expelled from the hotel. Despite the legal remedies available, no longer being physically present upsets the status quo and complicates the return to school.

Conversely, the owner must strategically plan the eviction of the operator. Despite an arbitration agreement, the owner must consider ex parte preemptive relief from a supportive court to evict the operator and remove the flag. Then, stubbornly hold the position during and until the conclusion of the arbitration. The element of surprise is essential. This necessarily means a Navy SEAL operation with a new operator on the prowl. This incoming operator usually expects to be comforted by an indemnity from the owner against the legal ricochet of the outgoing operator.

AH and Arbitrations

Most operators prefer arbitrations because they are private and reduce the chances of other owners getting similar ideas. Taking into account the choice of law by the parties in the HA weighs heavily on the arbitration strategy. This implies giving weight not only to the applicable law and the law of the seat, but also to the law of the place where the hotel is located. The latter was a blind spot for the arbitral parties with unintended consequences for them in the final award.

Arbitration practitioners should therefore be aware of the above considerations. They regularly appear as contentious issues and significantly influence the outcome of the arbitration.

*Warning: The content of this interview does not reflect the official views of the International Chamber of Commerce. The opinions expressed are solely those of the authors and other contributors. The foregoing does not constitute and is not intended to constitute legal advice; instead, all information, content and materials available are for general informational purposes only. Readers get advice on any particular legal issue.

Nicholas E. Crittendon