How Does a Hotel Owner Identify an Appropriate Hotel Operator for Their Hotel?
Careful attention to the process by which a hotel operator is identified for the management of a hotel can ultimately impact the owner’s future profits. While certain operators may have higher brand recognition and, therefore, desirability, these parties may have less amenable operating terms which affect the owner’s “bottom line”. Accordingly, it is important to compare the key terms of prospective operators to ensure that the best deal possible is obtained. In this regard, some owners choose to consider a tender process, whereby operators disclose the terms on which they would contract with the owner up front, allowing the owner to make a comparative assessment. Alternatively, commercial and legal advisors may be able to indicate if the terms proposed by a prospective operator are “within range”, based on prior deals they have worked on.
Beyond this, it is important to conduct a basic due diligence of the operator party to ensure their financial stability and identify any risks to the operation. In certain cases, a parent company guarantee from the hotel operator may also be advisable, to guarantee the acts of the operator party (particularly where the operation is run through a “shell” company, with limited resources).
Finally, the owner should also invest significant time to confirm there is a genuine “relationship fit” with the proposed operator. With the initial term of an Operation Agreement often lasting around 20 years, a positive, cooperative working relationship is vital to ensuring the long-term success of the hotel.
What Happens Once an Appropriate Operator is Chosen?
Once an Operator is chosen, what usually happens is often different than what should happen. Typically, many owners execute a Heads of Agreement (HOA), a Letter of Intent (LOI) or a Memorandum of Understanding (MOU), with a view to involve legal counsel subsequently, when the definitive hotel management and related contracts are provided by the operator. Unfortunately, this means that the critical terms of an often more than 20-year arrangement are quickly agreed under such HOA, LOI or MOU, with little, if any, expert negotiation. If the operator is unwilling to re-open these terms during the later negotiation stages, this can have devastating effects. Owners are accordingly advised to ensure that legal counsel with experience in the hospitality field, are engaged at an early stage. Ideally such counsel should then be retained for negotiation and revision of the definitive agreements, which may number up to nine, although the level of engagement and assistance can be varied to adapt to the owner’s requirements.
Must the Operator Establish a Corporate Presence in the Country of Operation?
Generally speaking, the question of whether an operator must establish a presence in the Arabian Gulf states in order to carry on its hotel operation hinges on whether it is “trading” or “investing” in the economy of the relevant territory or – as it is colloquially termed – “doing business”. Unfortunately, most Gulf countries do not have any clear legal test by which to verify if Operators are actually “doing business” in the states. A practice has accordingly evolved whereby legal practitioners will conduct a comprehensive assessment as to the precise activities and structure of a particular venture, to determine whether these might reasonably suggest in-country (as opposed to cross-border) trading or investment. In the context of a hotel operation, this will include consideration of such matters as who will carry out the implementation of the proposed hotel operations and which party will employ the persons responsible for such implementation, and the extent to which the operator will carry on services relating to the proposed hotel within the country and the extent to which such services are provided from a foreign territory.
Can the Operator Employ the Hotel Employees Directly?
Generally the operator cannot employ the hotel employees directly unless the operator has a legal corporate presence in the proposed country of operation. This is because, as a general rule, employees working in the Gulf States must be both employed and sponsored (for immigration purposes) by the same entity. The act of sponsorship is not, however, possible without an Immigration Card (or equivalent), which is issued only to those having a legal corporate presence in the relevant country.
How Can the Owner Ensure Maximum Performance Efforts by the Operator?
These days, carefully structured performance test provisions are standard in most Hotel Management Agreements. However, while at first glance these provisions may appear to provide helpful protection to a hotel owner, they will generally not go as far as they could or should to protect the owner. For example, they may offer the owner a right of termination where certain performance measures are not met while simultaneously stipulating a large number of circumstances where the right does not apply and/or providing the operator with the right to “cure” the failure (monetarily), in which case the termination right (which might be the most desirable option in the circumstances) is void.
What Financial Safeguards may be Agreed on to Protect an Owner?
One of the key tasks of a hospitality lawyer representing a hotel owner is to negotiate certain financial safeguards into their Hotel Management Agreement. While there are too many examples of these safeguards to include here, key among them are usually priority payment mechanisms- whereby the owner is provided a return on their investment before other amounts are paid to the operator- budget controls, and bank account signatory controls. These controls are often fiercely resisted by an operator, but can and do get accepted to varying degrees.
What Law Will Govern the Hotel Management Relationship and How May Disputes be Resolved?
Regrettably, hotel owners and operators sometimes end up in dispute. When this happens, a good Hotel Management Agreement should have stipulations detailing the parties’ agreement to both the governing law of their arrangements and how disputes may be resolved.
With regard to the governing law, although the jurisdictions of the Arabian Gulf states will generally allow contracting parties to freely select a law of their choice to govern their contractual arrangements, in practice, it is awkward to do so under the laws of a territory that is different to those of the Hotel’s location, as the operation of their hotel will be unavoidably subject to local law. For this reason, it is preferable to stipulate the local law of the place of operation of the hotel, as the governing law of all related contracts. Also, as many local laws in the Gulf States will apply mandatorily, notwithstanding the choice of a foreign governing law for the hotel contracts, it is arguably simpler to nominate local law.
With regard to disputes, the preferable mechanism for resolution will likely depend on the circumstances of the parties involved and the territory of the hotel. However, referral to international arbitration is often preferred by both owners and operators, with select (operational and budgetary) matters being referred to Hotel Experts.