Hotel operating companies are typically very reluctant litigants. However, in 2021, InterContinental Hotels Group (IHG), a major multinational hospitality operator, commenced legal proceedings at the Supreme Court of New South Wales, Australia after a hotel owner disposed of its property that was subject to a hotel management agreement (HMA) with IHG, in contravention of the hotel owner's contractual obligations under that HMA. Even though the hotel owner (the defendant) failed to make an appearance during the proceedings, the ensuing court decision is significant in upholding the importance of complying with contractual obligations and also in providing hotel owners and operators an insight as to the hefty financial detriment that can result from a breach.
The court case deals specifically with contractual obligations between an owner and an operator. However, in considering additional legal rights available to it, an operator may have the ability to claim (substantial) damages from those parties who assisted the owner in carrying out its breach.
Lastly there are strategies that a prudent operator may want to consider to minimize the potential risk of an owner divesting its hotel in breach of the owner's contractual obligations to an operator.
The court case - an owner's liability to an operator for breach
The key facts of IHG Hotels Management (Australia) Pty Ltd v Green Garden Development No 1 Pty Ltd  NSWSC 1310 ("IHG Case") are as follows:
Under the terms of the HMA with IHG, Green Garden Development No. 1 Pty Ltd ("Owner"), pursuant to its HMA with IHG, agreed to build and fit-out a hotel in Haymarket, Sydney and, as soon as the hotel was completed, to grant IHG the right to manage the hotel for an initial term of 20 years.
Under the terms of the HMA, the Owner was entitled to assign its interest in the HMA to a third party if it first obtained written consent of IHG. IHG was not to unreasonably withhold its consent if the hotel was sold or leased to a third party and the third party executed an appropriate deed agreeing to be bound by the HMA.
Contrary to the terms of the HMA, the Owner transferred the hotel land to a third party, Forte & LFG Pty Ltd ("Purchaser") without obtaining IHG's prior written consent and without the Purchaser agreeing to be bound by the terms of the HMA.The Court held that in doing so, the Owner had breached the HMA.
The Owner did not make an appearance during the legal proceedings and therefore did not submit a defence.
In awarding damages to IHG of approximately AUD 11 million plus costs, the Court accepted the argument that the measure of damages was to be determined based upon the aggregate fee stream and relevant expenses over the term of the HMA appropriately discounted to take into consideration the fact that payment would take place in one lump sum. The court considered three submissions of assessment of damages of which the awarded amount is the highest.
The case is the first occasion we have been able to find where a superior Australian Court has had to consider the damages payable to a hotel operator in relation to a termination due to a breach by the hotel owner of the HMA.
Should a case with substantially similar facts emerge in the future where the claim is contested by the hotel owner then we predict that the Court would find in favour of the hotel operator but there would be a robust contest as to the assessment of the operator's damages including the methodology of calculating the hotel operator's loss, mitigation of loss and other relevant matters that would factor into the assessment of damages at law.
Could anybody else potentially be liable to an operator?
The case serves as an important reminder to hotel owners of the significance of complying with its obligations under an HMA, but it also draws attention to the potential liability for other players involved in the transaction at the heart of the HMA breach - the transfer of the hotel to a purchaser.
If a party facilitates or is involved in such a transfer with knowledge that it is in breach of the HMA, the hotel operator is entitled to pursue legal action against that party pursuant to the operation of a legal doctrine known as tortious interference. A party may be liable for tortious interference where it intentionally induces or facilitates a hotel owner's breach of the HMA. To ground a case for tortious interference, a hotel operator would need to prove:
- There is a contract between the hotel operator and the hotel owner for the management of the hotel.
- The third party knows that such a contract exists (or takes such action or steps to deliberately prevent itself from knowing) (e.g., third party says to hotel owner "I don't want to know anything about your dealings with operator X").
- The third party knows that if the hotel owner did, or failed to do, a particular act, that act or omission would be a breach of the contract (for example, the owner selling the hotel without a novation of the contract to the purchaser).
- The third party intends to facilitate or be involved in the hotel owner's breach of the contract.
- The breach causes loss or damage to the hotel operator (e.g., loss of a substantial fee stream and any financial contribution that may have been provided to the hotel owner).
The relevant parties that are potentially at risk to a claim by the hotel operator could include any brokers, the purchaser, any incoming operator, their advisors and financiers.
If an action for tortious interference is successful, then it is very likely that any damages claim would be excluded from professional indemnity insurance policies.
What steps can an operator take to protect its interests?
In Australia, land interests are predominantly recorded on a land title register. A party may be able to prevent a dealing with land including a transfer, mortgage or lease by registering a caveat on the title of the land. Generally speaking, a caveat operates as a warning on a land title to others by noting a person's interest in the land. Essentially a party may only lodge a caveat if it has a 'caveatable interest' and satisfies the statutory requirements (which can vary slightly in each Australian state jurisdiction). , this being the first and key consideration to any proposed caveat as the lodging party is at risk of having to compensate anyone who suffers loss or damage as a result of the wrongfully lodged caveat.
As hotel management agreements are contractual service arrangements and do not create an interest in land, they do not in themselves confer a hotel operator a caveatable interest. However, an operator may have a caveatable interest if the commercial arrangements are that such an interest is formed. A detailed discussion is beyond the scope of this newsletter.
A caveat notation of the hotel operator's interest on the title of the land will understandably create concern for the owner, financiers and any other party with interests in the land. In our view, with proper consultation, any initial concern can be addressed.
The IHG Case is a watershed in the law dealing with HMAs in Australia. It is the first occasion that an Australian court has considered and determined the damages that are payable by a hotel owner to an operator on the early termination of an HMA due to the owner's breach.
It also prompts a timely reminder that liability for breach does not necessarily end with the party committing the breach. Through the doctrine of tortious interference, other parties may also be exposed to liability and suffer substantial damages.
While there may be steps that an operator can take to protect its interests where a hotel owner seeks to transfer the hotel without the operator's knowledge, at the end of the day, the key takeaway is that parties should always respect and comply with their contractual obligations and abide by those of other parties that they are in commercial dealings with.