In the wake of Fairmont v. Turnberry and M Waikiki LLC v. Marriott Hotel Services in 2012, the hospitality industry was abuzz about the dramatic ousters of the hotel operators by the hotel owners. The sensational events attracted even non-lawyers to read about these cases. A debate raged about whether a hotel owner should have the power to terminate a hotel management agreement at will, without notice or cause, and the effect this power would have on the hospitality industry, where the revenue streams from hotel management agreements are a key component in the valuation of brand management companies. As the hospitality industry reconsidered its business model in response to these cases, the setting continued to change as a result of the recent holdings in Marriott International v. Eden Roc and RC/PB, Inc. v. The Ritz Carlton Hotel Company.
Over the last two decades, the courthouse and arbitration proceedings saw a series of cases created by an owner terminating an operator in a way that was not recognized by the management agreement the parties had negotiated. The legal justification was the Restatement of Agency. The Restatement of Agency sets forth the common law concept that a principal (hotel owner) has the power to terminate an agent (hotel operator) at any time, unless the agency is coupled with an interest (an economic interest by the hotel operator in the hotel). In response to these proceedings, the industry attempted to circumvent the agency law concept by expressly disclaiming any agency in the agreement, but the courts instead looked to the actual relationship of the parties and held that the common law of agency trumps explicit contract language. Further, the courts have indicated that for an agency to be coupled with an interest, the hotel operator must have a specific, present, economic interest in the hotel. None of the courts applying agency law to hotel management agreements to date has found under the respective facts that the hotel operator held this type of interest. Without available guidance regarding the sufficiency of sliver equity or key money to create an agency coupled with an interest, to protect the management agreement by creating a sufficient interest may require substantial changes to the industry's current business model. Under the recent Eden Roc and Ritz Carlton cases, however, avoiding the application of agency law may not be enough to preserve the integrity of the management agreement.
Personal Service Contracts
In the Eden Roc and Ritz Carlton cases, applying New York and Florida law, respectively, the courts held that as a result of the delegation of a broad range of discretionary authority to the hotel operator (requiring the exercise of special skill and judgment), the hotel management agreements were personal services contracts, which may not be enforced by injunction or specific performance. The law regarding personal services contracts has its roots in the concepts of involuntary servitude and the difficulties courts would encounter in supervising the performance of special skills and judgment. The holding of both of these cases, which resulted in the hotel owner having the power to terminate the respective management agreement, turned on the court finding the hotel management agreement to be a personal services contract — not an agency law concept. Protecting the management agreement from agency law may no longer be enough.
Wrongful Termination Damages
It should be reiterated that although the hotel owner has been found to have the power to terminate its hotel management agreement under the concepts of agency law and personal services contracts, the hotel owner does not necessarily have the contractual right to do so and may still be liable for wrongful termination damages if the terms of the management agreement did not allow such termination. As most hotel management agreements eliminate punitive and consequential damages, the operator would attempt to collect as damages an approximation of the present value of the expected future management fees. If the remaining term of the management agreement is lengthy, as is typical, the damages may be a substantial amount.
As the conditions in which hotel management agreements are negotiated and enforced continues to change, it is critical to stay current to understand the practical effect of the agreements. This is especially true where the express terms of the agreement do not necessarily control the ultimate enforcement of the agreement as is the case in the areas of agency law and personal service contracts. There may not be complete certainty as the industry reacts in new and different ways, but each party will be able to best attempt to realize its intended results by understanding the uncertainty that exists.
If an environment continues where hotel owners are willing to terminate their management agreements at any cost, further changes are anticipated as new facts are presented. For example, there has not been a ruling as of yet that clarifies the application of the personal service contract concept when an agency with an interest has been established by the hotel operator (although the Ritz Carlton case does mention in dicta that an agency coupled with an interest would be an exception to the law regarding personal services contract, it is not certain if this would be followed). Further, in the cases to date, the hotel management agreements were not subject to the Maryland operating agreement statute so that the application and enforceability of this statute remains untested.
In negotiating management agreements, the parties should go into the negotiations with this environment in mind. If the hotel owners continue to have the power to terminate these agreements at will, the hotel operator needs to consider whether the recovery of damages would make it whole considering not only the loss of revenue stream but also the loss of location, brand-reputation damage and litigation costs, and also give attention to the liquidated damage and dispute resolution provisions of the agreement as well as the collectability from the hotel ownership entity. As the industry continues to react to these changing conditions, other alternatives have been considered, such as a "wrongful termination guaranty" from collectable owner parties or changes to the business model to include a present economic interest in the hotel.
All parties in the hospitality industry love "heads in beds," but expect the operator side not to take this personal service contract trend lying down.