Having represented management companies and owner/developers in projects ranging from five-star mixed-use luxury branded resorts to limited-service highway franchised hotels, I have had the opportunity to work on many branded management agreements, third-party management agreements (non-branded) and franchise agreements. From my years of experience, I've compiled a list of key terms and tips for you to live by.

In this article we will look at the key terms of a Hotel Management Agreement (HMA) that form the basis of the 'bargain' between the management company and the owner in a typical, full-service branded hotel management agreement. These are the provisions that are likely to be negotiated over a period of weeks, even months, assuming bargaining strength exists on both sides of the negotiating table.

The trend is to set out the basic business terms first in a Letter of Intent (LOI) before proceeding to the 'definitive document' phase. Here are those key terms on which there should be a 'meeting of the minds' before the parties may conclude that they have come to agreement on the terms of an HMA:

Some basics:

  • Brand Selection: Is the chosen brand right for the location? Has a feasibility study been done to confirm this? Is there competition in the market that will dilute the brand's effectiveness? Does the developer have the required financing (equity and debt) to build to the brand standards?
  • Identification of the Parties: Is the developer entity the ultimate owner or will the developer negotiating the terms instead be a partner, member or shareholder in the entity into which equity investments will be made?
  • Description of the 'Hotel' or 'Project': Are all hotel rooms 'dedicated' as full-time hotel space or are there 'condo-hotel' units available as hotel 'keys' when the unit owner is not in occupancy? Is commercial space to be managed as part of the Hotel or leased to an operator, which affects how revenue is treated? Are there other not-strictly-hotel uses – perhaps a parking garage or amenities such as a spa or resort facilities – that are to be included in the scope of management?
  • Residences: Will they be branded, marketed and managed by the management company? What hotel amenities will be available to residence owners? What is the split of rental proceeds with residence owners?

Once you have a fundamental understanding of these, you can then focus on what is actually negotiable in the HMA:

1. Term:

The term tends to be longer for branded management agreements – 20 years these days with perhaps one ten-year renewal at the management company's election, conditioned perhaps and with no prior failures of the performance test (see below). Third-party (non-branded) management agreements tend to be much shorter duration. The HMA typically may not be terminated by the owner with the payment of an agreed termination fee (liquidated damages), but this is becoming more common.

2. Performance Test:

This is typically a two-pronged test. For example, the management company must achieve 90% of budgeted GOP and 85% of the RevPAR of an agreed competitive; with failure to meet both tests for two consecutive years (or sometimes two out of three) constituting a failure of the performance test that may be 'cured' by the management company's paying to cure one of the budgeted GOP shortfalls. A more meaningful test for the owner would be a bottom line NOI test, but management companies generally decline to be evaluated that low in the hotels.

3. Revenue-Based Fees:

Base fees, typically 3% or 4% of total revenue, plus perhaps a marketing fee of 1%, are generally not negotiable. But an owner may obtain a ramp up in the early years of a new hotel until stabilization. These are overhead recovery fees by the management company. There has to be clarity as to what is and is not included in total revenue. For example, only the net rent from space leased to third parties, such as sundry shops, rather than the third-party's total revenue, is included in the hotel's top-line revenue number.

4. Incentive Fee:

This fee rewards not just volume (which is measured by total revenue) but also operating efficiency, by basing the fee on GOP (typically 8% to 12%). GOP is arrived at by deducting from total revenue those operating expenses within the management company's control. This fee is ripe for negotiation, with owners wanting more expenses deducted and perhaps an 'owner's priority' that must be satisfied, such as a return on the owner's total investment in the project or debt service, before the incentive fee is paid. Another issue: are unpaid fees 'earned' and therefore accrued to be paid at a later date from excess earnings? There are many variations to how the incentive fee is determined.

5. Other Charges:

There are many other fee opportunities for and impositions from management companies, such as reservation fees, reward programs charges, employee training charges, technical services fees, optional purchasing programs, brand marketing cost reimbursements and other programs for which the management company charges all managed hotels. Allocation of these charges to participating hotels is a topic that owners will want to explore. These charges may be hard to predict unless the owner looks to a similar hotel managed by the same management company for some idea as to what to expect.

6. FF&E Reserve:

Generally this is funded from hotel operations and is 4-5% of total revenue that is set aside for replacement of FF&E (soft goods, carpets and the like).

7. Budget Approval by Owner: The owner will always want more than just a right to review the budget that the management company prepares, and generally owner approval is allowed. But some items can be excluded from the owner's approval right, such as the cost of utilities or the central service charges. Items in dispute can be set at the prior fiscal year's level plus a CPI-based increase pending resolution by an expert.

8. Capital Expenditures:

The owner must fund all CAPEX to achieve compliance with brand standards, life safety requirements and legal compliance.

9. Owner's Financing: The management company will seek to impose limitations on the owner's debt level to avoid over-leveraging and is likely to seek a Subordination Non-Disturbance Agreement (SNDA). In these instances, the management company acknowledges that its fees are subordinate in priority to debt service (but typically only after a default by the owner under the loan agreement) and the lender agrees to keep the management company in place after a foreclosure.

10. Credit Enhancements:

These are sometimes provided by management companies to enhance the owner's ability to finance the hotel. Indeed, they take many forms, such as a contribution of technical services, key money (an outright grant paid on opening that's recoverable if the management agreement is terminated early), debt service guarantees and more.

11. Employees: In the U.S., the management company typically employs all hotel employees, with the unintended consequence of preventing the owner from obtaining a roster of each employee's salary and benefits out of privacy considerations. Outside the U.S., the owner acts as the employer, but the management company will assign certain experienced personnel to serve in key positions such as the Executive Committee. These key personnel will usually exit the property when the HMA is terminated or expires. In many jurisdictions, hotel employees will be deemed to be jointly employed by both the management company and the owner for purposes of assessing liability to the employer for conduct of the employees.

12. Hiring and Firing Key Personnel:

The owner typically requests and obtains the right to interview candidates and approve the hiring of key personnel such as the General Manager, Controller, and Director of Marketing and Sales. However, management companies may be able to negotiate limits as to how many qualified candidates can be rejected by the owner before the management company is able to hire its choice for best candidate. The owner may also obtain the management company's good faith consideration to the owner's complaints about the performance of personnel, but the decision to fire or not is generally solely the management company's decision.

13. Indemnification and Insurance:

It's typical for the management company to expect the owner to indemnify the management company against all claims, losses and liabilities, except for those arising out of the management company's acts that constitute willful misconduct or gross negligence. For the management company's indemnification to be meaningful to the owner, acts of key employees should be attributed to the management company. Ultimately, liability insurance coverage of both the management company and the owner under the same policy is the means by which both parties are protected from third-party hotel-related claims, such as 'slips and falls'.

14. Damage and Destruction: Property insurance is provided by the owner with coverage acceptable to the management company. The owner will have to apply insurance proceeds to repair the hotel, but may have a termination right if the damage is severe.

15. Sale of the Asset:

Typically, the management company can stipulate that its agreement survive a sale of the hotel and that certain purchasers be prohibited, such as competitors, purchasers with criminal backgrounds or buyers with other legal issues.

16. Agency:

HMAs have been held by many courts to constitute agency appointments by the owner as 'principal' and the management company as 'agent'. For this, there are two consequences: (a) the owner has the power to terminate the HMA at any time for any or no reason, but may face a damage claim from the management company under contract law for wrongful termination; and (b) the management company owes the owner a fiduciary duty. This area of law is complex and experienced counsel is required to advise both parties as to its implications. These agreements have also been held to be personal service contracts with the owner having the same power to terminate the agreement as if it were an agency appointment.

These are many but not all of the negotiating considerations. Many other areas are addressed in the HMA, such as governing law, dispute resolution and more. Management HMAs have evolved since their first appearance in the early 1950s to the point of becoming highly specialized in their vocabulary, business terms and legal interpretation. They require experienced counsel as well as hotel development and operational expertise. Industry custom has rendered these agreements somewhat 'standard' in appearance nowadays, but there is plenty of room to negotiate the key terms.