10 CONTRACTUAL ISSUES FOR HOTEL OWNER-OPERATORS

The recent wave of operator consolidations and an uncertain geopolitical environment have produced several new legal and contractual issues linked to the hotel owneroperator relationship. Scott Antel, partner and head of Hospitality & Leisure MEA, Berwin

1. Brand dilution/de-emphasis

Recent mergers (Marriott-starwood being a good example) have created mega-hotel companies, with a number of overlapping, same-market, brands. This results in a potential dilution or deemphasizing of one brand at the expense of the other. What to do if you are the current or future owner of a property, under a 25-year term contract, with a brand which the operator has decided to de-emphasize? Who is going to pay for any rebranding? Should not this be a material change, allowing for at least a right to early-contract termination? Therefore, including brand de-emphasis clauses in contracts addressing this issue is becoming crucial, in order to protect the owner’s rights in such events.

2. Sector vs. Brand

Brands will argue that consolidation is in the owner’s interest, by bringing scale economies and greater ability to compete against online travel agents (OTAS). The reality is that your former local ‘non-compete’ brand specific, may be rendered obsolete by a merger, with your operator running a hotel that used to be a competitor next door. What if that former independent-brand competitor offers a better return to the operator than your hotel? Which hotel will the operator decide to focus on and push business to under its distribution system? While one can argue for some synergy and scale savings arising from having both brands under one operator, there is no denying a potential conflict of interest. We are insisting that any territorial clauses restriction must be marketsector specific, and not brand specific, to address this issue.

An owner should have the right to an early termination without cause, albeit with reasonable compensation to the operator

3. Termination without cause

Consolidation, the growth of OTA booking channels, and other factors have fundamentally changed the owneroperator relationship, making it less personal. Operators today are more focused on managing their brands rather than on managing the individual hotel. While the operator you originally signed up with for a 25-year contract can, through mergers and acquisitions, change beyond all recognition, you are expected to remain static. However, with the changing economies, an owner should have the right to an early termination without cause, albeit with reasonable compensation to the operator, and not before a time period following stabilization (e.g., five-to-seven years).

4. Performance tests that work

The only time I have seen a performance test clause triggered was as a result of currency fluctuations and in this situation, the operator was actually doing a good job! With the changing nature of the industry, the standard percentage of gross operating profit (GOP) and the revenue per available room (REVPAR) and competitive set performance tests (measures inevitably skewed in the operator’s favor), needs to be tightened up and/or expanded. Social media (e.g., Tripadvisor) ratings, as well as minimum thresholds measuring the levels of distribution delivered via the brand’s online distribution systems vs. OTAS, can reveal a lot about the brand’s performance.

5. Central marketing fees on OTA bookings

A brand’s distribution system represents its strong value proposition to the owner, who is asked to contribute to this via charged central services and marketing (CSM). However, the owner pays the same CSM fees today as he did prior to OTAS. Thus, he is paying the OTAS a fairly substantial fee, on top of the operator’s fee for involuntarily outsourcing the booking that the brand once did to the OTA. This very real dilution in the brand’s distribution delivery needs to be reflected in the management contract fee structure.

6. ‘Mcdonaldization’ of scale

It is inevitable that with size comes standardization, commoditization and less personal attention or feeling of a partnering relationship. Your property becomes, on a wider scale, less important to the operator, yet you pay the same as before. In your contract, insist on the right to regular head office visits or clear and responsive channels to make sure your property and its individual issues remain high on the operator’s agenda.

7. Pay your taxes

It is surprising how many contracts in the Middle East do not include tax clauses on who pays taxes, as well as provisions on seeking potential tax treaty relief. Many operators will say these are not necessary as there are (e.g., in UAE) no taxes. Well, taxes will come within the term of your hotel management agreement and you need to provide for who pays. The market standard should be that the operator pays any tax on the profit-bearing base and incentive fees with reimbursable fees, such as technical service and central service charges having a ‘gross up’ for any taxes payable. The operator should be obliged to obtain any tax residence or other documentation enabling the parties to claim any tax treaty benefits.

8. Consolidation restructuring costs

It is inevitable that operators will incur restructuring costs once consolidation has taken place. This will involve amendments to your agreement and potential costs, including legal and registration fees, and potential additional tax costs. Make sure that any potential costs are addressed and that you as an owner are adequately protected.

9. Recognizing a maturing market

The Middle East hotel market is no longer 'emerging'. Many owners today are quite sophisticated and have solid asset management and market knowhow. Contrast this with operators’ tendency to focus more heavily on managing their brands than managing hotels, and the suggestion is that owners and their asset managers should have a greater say in running the business effectively. Make sure that your contracts call for regular owner-operator meetings and reporting, and insist on these having a substantive dialogue, including the implementation of valid owner concerns and recommendations.

10. Reverse sanctions

Virtually all management contracts have restricted/sanctioned persons clauses, drafted from the operator’s perspective. With more global uncertainty both in the Middle East and elsewhere, the owner’s own sanctions or reputational issues need to be accounted for: Consider the implications of owning a ‘Trump’ branded hotel in the Middle East or potential country sanctions on operators from certain jurisdictions. This is no longer a one-way street of reputational risk.

Consider the implications of owning a ‘Trump’ branded hotel in the Middle East or potential country sanctions on operators from certain jurisdictions