We are currently running a 10-part series discussing particular provisions and concepts within hotel management agreements.
The purpose of this series is to discuss common hotel management agreement provisions and concepts from the perspective of both hotel managers and hotel owners. Hopefully we will touch upon one or more topics which spark an "I've always wondered why that is the way it is but nobody has taken the time to explain it" reaction with you. We trust the discussion goes some way to demystify the topic.
Our 10-part series will cover the following topics:
- Why is the manager's fee based on hotel's revenue and profit and not some other basis?
- Why do some agreements provide that the manager is the owner's agent and some do not?
- Why does the owner employ most or all of the hotel employees (and not the manager)?
- What is the risk/reward relationship between an owner and manager?
- Why does the owner indemnify the manager?
- Why do we need a non-disturbance deed between the owner, manager and financier?
- Why the need for an area of protection?
- Why is the owner usually prevented from selling the hotel to one of the manager's competitors?
- Why does the manager impose restrictions on the owner's ability to finance the hotel?
- What is the importance of brand standards?
Today, we will continue this series with the fifth topic.
Why does the owner indemnify the manager?
In the experience of the authors of this article, the amount of time spent arguing about manager indemnities in hotel management agreement negotiations is inversely proportional to the practical significance of such indemnities.
With these potentially controversial opening remarks, we will now delve a little deeper into the detail of this topic.
Under a typical hotel management agreement, the hotel business is the owner's business. The owner is entitled to all profits which the business generates and is liable for all losses it incurs. The owner engages the manager to supervise all business activities on a day to day basis. The manager is a service provider who is paid a fee for the provision of these services.
While only being a service provider for the owner’s business, the manager could be exposed to legal liability arising from the business in a variety of ways. It will incur liability if it purchases goods and services and enters into other contracts for the business on behalf of the owner, which can result in the potential for legal proceedings being brought against the manager. Equally, the manager can be made a defendant in legal proceedings relating to the business by virtue of its high visibility with respect to the business. For example, if a hotel guest slips over and is injured in the hotel, or a disgruntled employee wishes to take action, then the manager could be joined in any legal proceedings.
Because of the service provider role that the manager undertakes, it is customary for the owner to indemnify the manager for any costs or expenses it may incur as a result. Therefore, the purpose of the indemnity is to fully compensate the manager for any loss or expense to which it is exposed or, in other words, "to make the manager whole" in the normal course of the hotel operations.
There are normal exceptions, however, to the scope and extent of the indemnity. Typically, the indemnity will not usually apply if the event, which gives rise to the indemnity claim is due to the gross negligence, wilful misconduct or fraud of the manager. Some lawyers will spend days arguing whether the indemnity exclusion should relate to the manager's "negligence" or the manager's "gross negligence". A pitched battle over such an issue would seem misguided. In reality, only substantial claims, not already covered by insurance, will warrant a real life contest between the manager and the owner, and it will be evident whether the degree of manager’s fault has been a major contributing factor. In these circumstances, technical distinctions between such concepts may, we suggest, be more apparent than real.
In reality, the availability of adequate insurance cover, with respect to the owner and the manager, will go a long way in minimising the practical impact of the indemnity. This is because insurance cover for these matters are essentially “event-based” rather than “fault-based”. We should also mention that, whilst we cannot discount the prospect that indemnity claims may arise, the authors have never witnessed a situation where this has in fact occurred.
Some novice owners adopt the "tit for tat" approach to indemnities. In other words, if the owner is required to provide an indemnity to the manager, then the manager should provide a similar indemnity to the owner. Such an analysis fails to pay due regard to the essence of the legal relationship between the parties.