Mr. Brewer III

Hospitality Law

Upon Closer Review: How Hotel Management Agreements Are Interpreted - and Enforced

By William A. Brewer III, Managing Partner, Bickel & Brewer

As we know from experience, the economic pressures affecting the hospitality industry can create contract-related pressures for hotel owners and operators. As an example, disputes frequently arise during economic downturns between hotel owners and operators concerning their rights and duties under their management agreements. The industry's key players need to understand how hotel management agreements are likely to be interpreted and what they can do to protect their rights.

There is no question that we are in the midst of a severe economic downturn. The hospitality industry is no exception. Smith Travel Research reports that the U.S. hotel industry experienced a year-over-year decrease in occupancy, ADR, and RevPAR in December 2008, with the luxury hotel segment being hit hardest. That trend is expected to continue in 2009, as consumers reduce their travel and luxury expenditures. According to Hudson Crossing, "the global hotel industry will manage this downturn better than 2002-2003, but will feel the full brunt of the economy in late 2009." Hotel asset values have also plunged. Lodging Econometrics reports that the average price per room fell to $85,863 in the third quarter of 2008, after reaching a high of $121,282 in 2007. Another industry metric, global hotel transaction volume, dropped 80% in 2008, according to Jones Lang LaSalle Hotels, and is expected to fall ever further in 2009.

While the events leading up to this recession and its impact on the global economy are certainly unique, the hospitality industry has weathered prior downturns. As we know from experience, the economic pressures affecting the hospitality industry can create contract-related pressures for hotel owners and operators.

As an example, disputes frequently arise during economic downturns between hotel owners and operators concerning their rights and duties under their management agreements. The industry's key players need to understand how hotel management agreements are likely to be interpreted and what they can do to protect their rights.

A. Hotel Management Agreements: The Basic Framework

In general, management agreements govern the relationship between hotel owners and operators by setting forth each party's rights and responsibilities for the day-to-day operation and management of a hotel. They define, among other things, the term (i.e., time period) of the agreement, operating fees, operator guarantees, performance measures, owner approvals, capital expenditures, events of default, termination rights (if any), intellectual property rights, territorial rights and/or restrictions, and dispute resolution procedures. Management agreements are, thus, the mechanism for allocating and managing risks between owners and operators. Yet, despite their importance, management agreements are often negotiated, executed, and then put in a file until a dispute arises. All the more reason in these circumstances for owners and operators to audit their rights and responsibilities under their hotel management agreements.

B. If a Dispute Arises, How Will the Management Agreement be Interpreted?

In any dispute between an owner and operator, the starting point for understanding the parties' rights and obligations is the plain language of the management agreement. The agreement will be interpreted as a whole so that each term is read in context and given meaning. The cardinal rule of contract construction is that the parties' intent governs, and a court will look to the plain language of the contract to ascertain that intent. The custom and general usage of the management agreement's terms may also be considered. Only where the relevant provisions are found to be vague or ambiguous will a court look outside the "four corners" of the agreement and consider other evidence of the parties' intent at the time the agreement was executed.

Perhaps one of the most important questions that arises in interpreting a management agreement is whether the agreement creates an agency relationship between the owner and operator. Since Woolley v. Embassy Suites, Inc., 227 Cal. App. 3d 1520 (Cal. Ct. App. 1991) was decided by a California court in the early 1990's, courts have routinely found an agency relationship to exist where a hotel owner authorizes an operator to act for, on behalf of, and on the account of the owner - with power to bind the owner. In some cases, an implied agency relationship has been found to exist even where a management agreement expressly states that the operator is "not an agent." This is significant because, if an agency relationship exists, there are additional rights and duties that arise as a matter of law.

If a management agreement is found to create either an express or implied agency relationship, an operator will be deemed to be a fiduciary. The operator will owe the owner fiduciary duties, such as loyalty, confidentiality, and good faith and fair dealing. Such duties, in turn, will affect how the parties' agreement is interpreted. For example, an agreement containing a territorial restriction may bar the operator from managing another hotel under the same brand in the restricted territory. However, if the operator is a fiduciary, a court may hold that the duties of good faith and loyalty may prevent the operator from competing with the owner by managing any other hotel in the area, even if it is under a different brand. Likewise, an operator's fiduciary duties may limit its ability to use hotel specific information, such as occupancy and revenue rates, to market or promote other hotels that are also managed by the operator. Finally, an agency relationship may provide the parties with certain termination rights in addition to those set forth in the agreement, because a breach of fiduciary duties may give rise to a common law right to terminate that is in addition to the events of termination spelled out in the management agreement.

Although these extra-contractual duties may be superficially appealing to an owner and potentially troublesome to an operator, it is in both parties interest that the full extent of their rights and duties be clearly set forth in the management agreement. Parties need to be in sync about the terms of their deal, and having a clear understanding of those terms will reduce the probability of a dispute in the long-run. Moreover, to the extent the parties limit or delineate the scope of any implied duties, they will also increase the certainty that the management agreement will be interpreted as expected should a dispute arise. Of course, the last thing either party wants is to find out that an implied duty is or is not in management agreement after engaging in time-consuming, costly litigation.

C. What Can be Done to Increase the Likelihood That a Management Agreement Will be Enforced as Expected?

Owners and operators entering into a management agreement can increase the likelihood that their agreements will be interpreted as expected by expressly limiting any implied duties. There are two ways in which they may address the extra-contractual duties that sit on top of and supplement the terms of the management agreement. One option is to specify that Maryland law applies to and governs the interpretation of the management agreement. The other option is to specifically set forth the full extent of the parties' rights and duties in the management agreement and clearly disclaim all other duties not expressly identified therein.

The Maryland Commercial Law is a clear response to courts implying duties in a management agreement based on an agency relationship. It provides that the express terms of the management agreement control, regardless of whether those terms conflict with principles of agency law. The law recognizes an implied duty of good faith and fair dealing in management agreements, but permits parties to modify even that duty for certain obligations that may be performed "in the party's sole discretion." Finally, the law provides that no duties will be implied in the agreement unless otherwise stated. Although some commentators view the Maryland law as being one-sided in favor of operators, the law benefits both owners and operators by providing a degree of certainty that the negotiated terms an agreement will be interpreted and enforced as written. In order to obtain the benefits afforded by the Maryland law, an agreement should expressly state that Maryland law applies and that its provisions should be interpreted and enforced in accordance with the Maryland Commercial Law.

As an alternative, parties may limit or proscribe the extra-contractual duties that arise from an agency relationship by specifically defining the full extent of duties and obligations owed to one another in the management agreement. Thus, to increase the likelihood that a management agreement will be enforced according to its terms, parties should clearly and accurately spell out their relationship and the duties owed to one another in the agreement. The management agreement should also include a provision that expressly disclaims any implied duties and further state that the only duties owed under the contract are those that are specifically set forth therein.

For owners and operators that have already entered into management agreements, now is the time pull them out and get reacquainted. All too often, parties treat management contracts like insurance policies - they are filed away until a problem arises. At that point, however, it may be too late to protect their rights. Given the economic pressures of the current downturn, there is a higher probability of contractual disputes and parties should be aware of terms of their management agreements and any extra-contractual duties that may arise by virtue of the parties' relationship. Indeed, even before a dispute arises, a party may be looking for a way to change the economics of their deal. It is thus important for parties to be familiar with and understand their rights and obligations under their management agreements. In doing so, they will be able to protect their rights and may even be able to avert a potential dispute.

Conclusion

Hotel management agreements are vital tools for owners and operators to define not only the economics of their deal, but also their relationship, and the duties owed to one another. In negotiating management agreements, parties should understand how the agreement may be interpreted down the road and take steps to limit any extra-contractual duties up front. For parties that have already executed management agreements, now is the time to conduct an audit of those agreements again to ensure that each party is complying with its obligations. In reviewing the agreement, parties should pay close attention to not only its terms and but also to any extra-contractual duties that may be implied by law. The pressures caused by the current economic downtown create a higher probability of contractual disputes which, in turn, create a higher probability of litigation. Parties, therefore, need to have a full understanding of their rights and responsibilities under their management agreements and, of course, be on the lookout.

Bickel & Brewer associate Eric P. Haas contributed to this article.

Under Mr. Brewer’s direction, Bickel & Brewer has become renowned for its innovative handling of major disputes in a number of industries, including the hospitality industry. Not only has his work in this area changed the state of the law, but it also has resulted in the formulation of creative solutions to countless problems confronting the industry. The firm has represented hotel franchisors, management companies, owners, developers, and investors in many of the highest-profile matters in the industry. Mr. Brewer is frequently published on a wide range of legal and business issues effecting the hospitality industry. He is a member of several leading industry associations, including the American Hotel & Motel Association and the Academy of Hospitality Industry Attorneys. Beyond these associations, Mr. Brewer is active in a broad range of professional groups and philanthropic organizations. Mr. Brewer III can be contacted at 214.653.4000 or wbrewer@bickelbrewer.com Extended Bio...

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