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 sparks a "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 second topic.
Why do some agreements provide that the manager is the owner's agent and some do not?
The form of hotel management agreements ("HMA"), which we are familiar with today, was developed initially around the 1950s. The basic premise is to achieve better business outcomes for both the owner and the manager through separation of ownership and professional operation of the hotel asset. By engaging a professional hotel manager, with a suitable brand and appropriate service capabilities to manage the hotel on the owner's behalf for a fee, the owner can focus on the investment, financing and construction aspects, rather than the operating and branding aspects, of the hotel. (That said, there are still a number of hotels, which are self-managed by the owners without outsourcing the daily operations to a professional manager.)
A fundamental legal feature of the HMA is that the manager operates the daily business of the hotel on the owner's behalf for a fee. Traditionally, this feature brings the relationship between an owner and a manager under a very old area of law called "agency", which exists in all major legal systems around the world.
Under Anglo-American common law traditions, if the manager is determined to be acting as an agent of the owner in the management of the hotel business, the manager is generally required to bear "fiduciary duties" towards the owner. In contrast, under other legal systems (such as China), the concept of "fiduciary duties" is more applicable to certain unique relationships such as "director and company" and "lawyer and client", rather than all types of agent-principal relationship.
Under Anglo-American common law rules on fiduciary duties of agents, the agent must generally act in the best interests of the principal. Further, the agent must not derive any profit without the principal's informed consent. In a hotel management context, this is relevant particularly to rebates on purchasing contracts. Following a number of United States court decisions on this issue, most if not all international hotel management groups do account to the owners for the rebates that they receive on purchasing contracts or other payments. This is due to its relationship with particular suppliers, and the fact that it may be able to buy in bulk, because it is ordering for more than one of its owners at any time.
There remains different views in the industry as to the most legally appropriate way to reflect the complex, long-term business relationship between a hotel owner and a manager. From the owner's perspective, it is preferable for the manager to be the owner's agent rather than a mere "independent contractor", where such fiduciary duties are not owed. There is no reason why each of the fiduciary duties cannot be spelt out in the HMA, but this is a more complex route than simply relying on the law of agency.
From the manager's perspective, while the manager does operate the hotel on the owner's behalf for a fee, the business relationship between them is inherently different from that between "director and company", "lawyer and client" or other types of fiduciary agents and principals. It is therefore proper for the parties to clarify, expand or limit the "agent's fiduciary duties" in the HMA as they consider appropriate through arms-length negotiations.
In recent times, we have seen a trend to shift the nature of the owner-manager relationship from agency to "independent contractor" primarily with respect to HMAs in the United States. The generally understood reason for this shift is not to deprive the owner of the benefit of an agent's fiduciary duties, but rather, a reaction to certain United States court decisions, which apply a general legal doctrine that permits a principal to terminate its agent at any time. According to these court decisions, the hotel manager could claim damages against the owner, but the court would not grant specific performance of contract.
The manager's perspective is that, if two sophisticated business parties have clearly agreed on the specific scope of termination rights (after thorough negotiations on an arms-length basis and usually with assistance of legal counsels), the court should uphold and enforce the contractual terms freely agreed by the parties. Hence, in response to those United States court cases, some managers have also put emphasis in their HMAs with respect to the operator's legal remedies in the event of a "wrongful termination" by the owner.
In short, the legal issues and consequences of "agency" are viewed differently in different legal systems as well as between owners and managers. Hence, some HMAs contain express references to the "agency" capacity of the manager and some do not.