Let's Clear the Air about Hotel Management Agreements

by Jeffer Mangels Butler & Mitchell LLP

Over the past several months, a lot has been written about what hotel management agreements should or should not say. The Global Hospitality Group® at Jeffer Mangels Butler & Mitchell has been drafting and negotiating hotel managements for well more than twenty years. Our experience extends to virtually every brand and every significant independent manager, as well as many less well-known players. Based on that experience, we thought it would be helpful to "set the record straight" on some key issues that owners need to consider.

1. Owners and Managers are not partners. One of the common statements we hear from owners and managers is that the management agreement "aligns the interests" of the owner and the manager, and that the manager is "just like a partner" in the hotel. While the interests of the owner and manager can be reconciled, they are not aligned -- even when the operator makes an equity investment in the hotel. Managers, particularly brand managers, are focused on increasing the value of the brand they represent, while hotel owners are concerned about the value and income of a single property. Managers can "sacrifice" the profitability of a single property so long as the value of their portfolio is enhanced, and they get their money "off the top" from gross revenues, whether or not the hotel is profitable. Owners expect to profit from each property.

2. Managers are NOT taking ownership risk. While it's true that hotel managers take on some costs and risk in managing a property, the fact is that in almost all cases, their risk is dwarfed by the owner's risk. Owners are responsible for funding all of the costs of the hotel, regardless of its profitability; managers are not. Those who raise funds for charities often refer to the difference between "involvement" and "commitment." And they like to make an analogy to a ham and egg breakfast, where they say the chicken was involved, but the pig was committed. In the world of hotels, managers are "involved," but owners are "committed."

3. The Hotel Management Agreement is important. Many commentators, including those with experience in the industry, argue that the manager's track record is more important than the management agreement. We agree that an owner should verify the manager's track record before making a commitment. However, the track record alone is not enough. First, while every management company has a list of highly touted successes, every management company also has a less-publicized list of disappointments - the track record goes both ways. Beyond that, a hotel management agreement is a complex document that identifies the expectations of parties for a period of five, ten, twenty, fifty years or more. Over that period of time, a good track record can turn into a disappointment, and relying on decades-old assumptions may be disastrous.

4. Owners need meaningful approval rights. All of these factors lead to a key conclusion - owners need to have a meaningful say in hotel operations. While owners hire managers to operate properties because of their expertise, resources, personnel and reputation, the relationship between owners and operators is "asymmetrical," and the goals of the two differ. While managers like the idea of a 70's style management agreement, where the owner simply hands the keys to the manager and hopes for the best, today's owners are, and should be, vitally interested in operations. This means that owners should have clear oversight and approval rights over budgeting, expenditures and key operating decisions. They should not be dissuaded from exercising those rights because of an operator's track record.

5. The gap can be bridged. Despite the differences between owners and managers, the gap can be bridged, but to do so requires expertise and experience in the options and alternatives available to the parties. From the owner's point of view, an attorney that understands what managers need and how their requirements can be met, is essential. Just as important is bringing to the table advisors that can recommend meaningful and practical compromises, and who are known to be credible players in the industry.

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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