Hotel Management Agreement Dispute Resolution: A Critical Design Challenge

by Holland & Knight LLP
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It's a given that hotel owners and operators will have disputes. Some of those disputes, such as the annual budget, are easily susceptible to resolution, while others may result in the termination of the management agreement and one or both parties incurring millions of dollars in damages and legal costs. Careful design of the dispute resolution process can be as important to the success of a hospitality project as the design process for the hotel, amenities and back-of-the-house.

Notwithstanding the periodic disregard for express contract terms by courts and legislatures, the ultimate goal of any dispute resolution process should be to salvage the business relationship of the parties and provide each of the parties with the rights and remedies bargained for in the management agreement.

Interventional Phone Call by High-Level Executives

If line officers on the two sides can create a dispute, high-level executives may just resolve the matter with a phone call - the triumph of good business over human nature. Consideration should be given to having the management agreement require such a high-level discussion before a default notice is sent, suit filed or arbitration demanded. It might be the difference between resolving a dispute in 30 minutes and years of expensive legal wrangling.

The Expert Process

Some areas of disagreement arise repeatedly during the course of a long term management agreement. The most common example of this is the annual budget process, with the owner concerned about current capital needs and return on equity, and the operator focused on maintaining brand standards and successfully competing with the other properties in the performance test competitive set. Many management agreements call for the use of a knowledgeable industry expert (often a representative of a major hospitality consulting firm) to resolve the disagreement in accordance with the contract provisions in a very short time and with limited, specified submissions. Think of it as a single arbitrator on a news reporter's deadline. While this approach is commonly utilized, it remains important to carefully consider the "how" and "who" will resolve the dispute and have the management agreement reflect those details.

Pre-Suit Mediation

The next design decision is to determine the benefits of mediation before arbitration or litigation. Mediation has been demonstrated to frequently resolve disputes through mutual compromise and facilitated negotiations outside the adversarial setting of a trial or arbitration hearing. It also is very cost effective.

It might be said that, "All mediation is not created equal." Once you're in litigation, the court and state law control the mediation. If your contract provides for pre-suit mediation, the contract controls all aspects of the mediation process - from the selection of the mediator; the rules governing the mediation, when, relative to the completion of discovery or the approaching trial date, the mediation takes place; and whether the mediation will be facilitative or evaluative. Left to the governing law provision of the contract, the mediation process might well not be what either party had in mind. For example, in Florida, the only permitted method of mediation is facilitative, but in New York, the mediation is inherently evaluative.

Once the parties have decided whether, when and where they want mediation, then they should determine what method of mediation is appropriate. The parties can simply use the rules of one of the dispute resolution organizations (American Arbitration Association, JAMS, CPR or the International Chamber of Commerce) or they can add further detail on the mediation process. Qualifications of the mediator, the type of mediation, and the location and scheduling are major details that should be specified in the dispute resolution provision. The complexities and unique business aspects of the hospitality industry make it preferable for a mediator to be an expert in the hospitality industry. The experience of a "knowledgeable neutral" provides an ability to ask the questions that underlie the disagreement and impede a settlement.

Mediation and arbitration are sometimes combined in a hybrid process that utilizes the same neutral. These different forms of hybrid processes, including MedArb and ArbMed, have their own positives and negatives, and a detailed discussion is beyond the scope of this article. Opinions differ wildly on the appropriateness for hospitality industry disputes, and those opinions tend to be strongly held, in either case.

Litigation vs. Arbitration

If mediation does not result in a settlement, litigation or arbitration will determine the winner (although many in the industry question whether termination legal wars really produce any "winners"). Once a lawsuit is filed, the rules are set by state law and procedure. If the parties opt for arbitration, they generally have selected a sponsored set of rules (AAA, JAMS, CPR or the ICC). Each of these organization's rules from selection of the arbitrator (or arbitration panel) to the schedule and conduct of the arbitration hearing are different. It's important to understand the differences and areas that might be problematical for you. Each may be modified by contract, if the parties have done so in their contract, or by subsequent agreement. Arbitration has so many variables, from the makeup of the arbitration panel and its authority, to the application of governing law, venue, subpoenas' evidentiary rules, and even the important form and timing of the award and rights of appeal, that owners and operators should assume, when negotiating the contract, that there will be a dispute that will be decided in court or arbitration tribunal. This is but one of the almost infinite variations.

Arbitration is advantageous because the parties can either decide on the rules of one of the arbitration organizations or they can tailor the rules with further stipulations that fit their specific needs. The ability to tailor the process is important because it provides for predictable outcomes without incurring the additional expense of unnecessary process. However, arbitration comes with a very limited ability to appeal, whereas in litigation the parties have the benefit of oversight by an appeals court. Therefore, in choosing between litigation and arbitration the parties must balance the need to appeal against the potential for additional cost and unpredictability of the appeals process.

Where arbitration is the ultimate dispute resolution, it is particularly important to deal with the critical issue of grounds for appeal. One of the main reasons people favor arbitration is its finality and limitations on appeal. Losing parties often wish they had the ability to appeal a decision they deem inconsistent with the facts and the law as they see them. If not dealt with specifically and properly in the contract, the Federal Arbitration Act (FAA) will apply to the arbitration. Under the FAA, fraud is almost the only basis for an appeal - even if there has been a gross misapplication of law. This makes it advantageous for the parties to specify which rules and rights of appeal will apply and avoid the FAA. Where parties want to be able to appeal, a reasoned arbitration award should be specified in the dispute resolution provision. The rules the parties choose are particularly important when the parties are from different nations or U.S. law is to be applied to a hotel or resort in a foreign jurisdiction. The most commonly used rules for international parties are the AAA's ICDR rules and the ICC rules. These rules provide uniform methods of handling international disputes and are tailored to avoid the pitfalls of normal cross border litigation. Arbitration awards are easier to enforce in other countries than court judgments. This may be a determining factor in the parties' decision to utilize arbitration.

An arbitration clause should address the scope, location, language, date and duration of the arbitration hearing, along with the allocation of the cost. The clause should also address whether the unsuccessful party will pay or contribute to the payment of the arbitration fees as well as the prevailing party's attorneys' fees. The arbitration agreement may direct that neither party is permitted to reveal to the arbitrator the settlement demands or offers of any party to the arbitration in order to avoid influencing the tribunal. All testimony should be required to be under oath and the parties should decide whether a transcript of the arbitration hearing will be made available. These numerous items may turn out to be critical.

The decision of whether to litigate or arbitrate is sometimes based on which one recently worked well or badly for one side or the other. More generally, owners tend to prefer litigation and the public relations pressure it puts on operators, while operators tend to prefer arbitration with its inherent confidentiality. In arbitration, you can require that the panel consist of industry-knowledgeable attorneys or business professionals (or a mix of these two categories). Litigation, by contrast, is unlikely to proceed before a judge with hospitality industry knowledge or experience.

Conclusion

The long-term business relationships established in hospitality industry agreements are too important to leave to chance with rules and process chosen by others. Designing a fair and effective dispute resolution provision is the best way to ensure that the deal you've bargained for is the one you get. Parties would never treat the details of the brand standards for the building and equipment casually. The dispute resolution provision deserves the same care. Don't make the mistake of treating dispute resolution provisions as "just boilerplate." It's worth the time and effort to ensure that the dispute resolution process works as well as any other system in the hotel and any other provision of the hotel management agreement.

The author acknowledges the contributions of Summer Associate Robert E. Montejo in the Fort Lauderdale office for the preparation of this alert.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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