Franchise Agreements vs. Management Agreements: Which One Do I Choose?
By Nelson Migdal, Real Estate, Shareholder, Greenberg Traurig LLP
Co-authored by Samantha Ahuja, Attorney, Greenberg Traurig.
Branding of a hotel property is often a long and expensive proposition for the hotel owner with the tradeoff being access to an established customer base and extensive reservation and marketing system. Hotel owners are often faced with the difficult choice of balancing the potential benefits of a hotel brand with the expenses associated with obtaining and maintaining the mandated brand standards. In our current economic climate, this decision can be critical as the ability to obtain financing and/or stabilize profit and meet return-on-investment thresholds may turn on the economic terms with the hotel brand owner. The reputation, name and standard level of a brand owner and the expense restrictions of the hotel owner are key elements in determining and negotiating a franchise agreement or management agreement. Many hotel brands offer both options depending on the property location, size, amenities, length of engagement, brand level, and other related factors. So why choose a franchise agreement instead of a management agreement? Often it is simply because the hotel owner gains the benefits of the brand strength and presence with the potential for a lower cost. The very premise of a franchise agreement negates extensive revisions or changes to the form of the original franchise agreement provided by the brand owner. As a result, the negotiation process is limited in nature, not as lengthy and much more focused in its scope.
While the negotiation process of a franchise agreement may be less vigorous, certain terms are open for discussion and modification. For example, common changes to the form franchise agreement can include furniture and fixture reserve amounts and time periods, property improvement requirements and costs, assignment and financing provisions, and termination provisions. Other more property based modifications to the form franchise agreement may include territorial restrictions, management company approval, guarantees and term and renewal provisions. The liquidated damage provisions, budget approval process, and centralized services and related charges are areas which are usually standardized and not heavily negotiated. The leverage of the hotel owner to negotiate is often based on the strength and extent of the brand power contrasted with the need of the presence of the brand within a certain territory, the building structure and its character, and the age and marketing strategy of the brand itself.
Hotel owners are often left frustrated by the manner and tone in which franchise agreement negotiations take place. However, hotel owners often need the brand in order to obtain the necessary financing for the building or renovation of the property. Lenders are hesitant, even more so in this economy, to lend any money to a hotel owner that does not have the marketing prowess and customer base that many brands bring to the table. Additionally, hotel owners are left with greater flexibility in the management and operation of the hotel. Franchise agreements allow the hotel owner to engage an independent hotel manager that will operate the hotel pursuant to a separate management agreement. The ability to negotiate greater control, flexibility and oversight with the independent management company is great and allows for the hotel owner to potentially have a greater ability to react to economic changes that directly affect the hotel property and in turn, the profit generated by the hotel.
The other common agreement used to engage a hotel brand and operator is the "Management Agreement." The Management Agreement is a fairly voluminous document that incorporates access to the brand and the manager/operator based functions related to the hotel. The Management Agreement form provided by most brands results in lengthy and often costly negotiations related to essentially all aspects of the hotel property. The ability to negotiate is greatly enhanced when using a Management Agreement verses a franchise agreement. Additionally, lenders are now requiring, in essence, "a seat at the table" during the actual negotiation process. The addition of the lenders' "point-of-view" often greatly complicates matters between the parties and assists in the extending the length and extent of the actual engagement process between the parties.
Often the extent of the Management Agreement negotiation and resulting changes to the agreement is based on the complexity the property itself. Does the property include a conference center, multiple restaurants and bars, a roof-top entertainment venue, or other recreational facilities? The availability of such amenities can result in the need for greater specificity in definitions of gross revenues, expenses, management authority, staff hiring, reserves and engagement of third party operators. At the heart of the Management Agreement is the extent to which the hotel owner retains control over the operations and fiscal management of the hotel property. Further, the Management Agreement often requires the negotiation and execution of multiple related agreements, such as the license agreement (which grants the actual rights to use the brand to the hotel owner), and a consulting and technical services agreement.
An issue of major contention within a Management Agreement is the budget approval process. The line items which may be reviewed and the standard of review by the hotel owner are often detailed and nuanced. The ability of the brand owner to manage and control the standards by which the brand is maintained is contrasted with the hotel owner's need to control cash flow and the profit margin of the property itself. Items such as standard employee wages, yearly maintenance and upgrades, and other items directly related to the "brand standard" associated with the operator. However, the owner may be able to negotiate certain line items for a more discretionary standard of review if they are related to the addition of amenities to the existing property, long term leases and contracts, and those items which are a certain percentage above the previously approved budget. This process is more standardized and rarely modified from its original format within a franchise agreement.
The ultimate difference in the level of negotiation between the standard form franchise agreement and management agreement is the balance of control between the operator and hotel owner. In certain circumstances, particularly in the current environment, the branded hotel operator encourages a relationship with the hotel owner, even when based on a franchise agreement rather than a Management Agreement. The hotel owner is often still encouraged to seek a high-end brand in the early phases of construction when the lender wants to see a long-term relationship with an operator and brand as a condition of financing. No matter the reason, the fundamentals of each agreement lie in the level of control either party maintains during the relationship.
Samantha Ahuja contributed to this article. Ms. Ahuja is an attorney with the law firm of Greenberg Traurig. She focuses her practice on hotel acquisitions, operations, development and finance, condo hotels, hotel management agreements, and license agreement, general commercial real estate transactions, commercial leasing, various financing transactions involving lender and borrower representation. She can be contacted at 202-530-8552 or firstname.lastname@example.org
Nelson F. Migdal is a Principal Shareholder at Greenberg Traurig and head of the Mid-Atlantic Real Estate practice group. He has practiced hospitality law for over 25 years. He handled the management agreements for The Echelon Place, in Las Vegas. In Panama, as owner's counsel, he obtained the first "Trump" license in Central America. Nelson is owner's counsel for The Trump Soho Project, and handled the Exclusive License with Trump in Istanbul. Nelson is an officer of the Academy of Hospitality Industry Attorneys and a member of the International Society of Hospitality Consultants. Mr. Migdal can be contacted at 202-331-3180 or email@example.com Extended Bio...
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