COVID-19: Preparing for and Managing Disputes in the Hospitality Sector

Dechert LLP

Key Takeaways

  • The unprecedented and unforeseen difficulties currently faced by the hospitality industry will likely lead to disputes.
  • Hotel management agreements are likely to be a particular source of disputes, as well as loan agreements, insurance policies and customer-supplier contracts.
  • Industry participants should take steps now to prepare for, and if possible avoid, disputes.
  • When disputes arise, mechanisms can be adopted to resolve them as quickly and cost-effectively as possible. For example:
    • Arbitration can be used to circumvent the backlog that national courts will face in the foreseeable future due to the COVID-19 pandemic.
    • Arbitration’s flexibility allows parties to resolve their disputes by using procedures tailored to the physical and financial restrictions caused by COVID-19.

The COVID-19 pandemic, and the travel restrictions imposed in response, are already having a severe impact on the hospitality industry. In a previous blog post and podcast, Dechert’s Global Finance Group discussed certain key issues that lenders, hotel owners and operators should consider at this time. In this briefing, we address key commercial disputes that could arise out of the crisis and provide practical advice to assist participants in the hospitality industry in preparing for and managing these disputes.

Preparing for Potential Disputes

While hotel management agreements (HMAs) may be a primary source of disputes over the coming weeks and months, all participants in the hospitality industry may face difficulty in meeting their contractual obligations given the economic, social and other consequences of the pandemic. Weaker financial performance by operators, and a consequent failure to meet agreed budgets, may lead to disputes regarding whether certain contractual rights and/or obligations in HMAs have been triggered, such as obligations on owners to contribute capital, the right of owners to terminate the HMA or take over management of the hotel, and guarantees by which the operator underwrites an agreed return to the owner. In customer-supplier contacts, agreed deliveries may be deferred, contracted payments may be delayed and transactions that should have closed may be abandoned. In order to prepare for potential disputes, businesses should:

  • Analyze contractual clauses allowing for the suspension or modification of contractual obligations, including of force majeure, material adverse change, renegotiation, hardship and similar clauses. In the absence of any such clauses, consider whether analogous legal doctrines may be applicable (such as force majeure in civil law jurisdictions, or frustration, impossibility and impracticability in common law jurisdictions).
  • Review insurance and debt finance agreements. For insurance policies, identify any gaps in coverage and consider the cost-benefit of obtaining any additional coverage. For debt finance agreements, ascertain the point at which "event of default" or similar provisions may be triggered by a drop in revenue.
  • Establish early communication and adhere to any contractually mandated notice requirements.
  • In advance of formally commencing a dispute, consider sending pre-action claim letters and consider using draft notices of arbitration, which can escalate pressure on a counterparty and potentially lead to a settlement.
  • If there is room to renegotiate force majeure and hardship clauses, consider using the model clauses recently provided by the ICC for international contracts, which aim to overcome the difficulties associated with the differences in the concepts of force majeure and hardship from country to country.1

Managing Disputes That Do Arise

If a dispute does arise, businesses should consider whether the contractually specified method for dispute resolution (which may have been agreed years ago in substantially different circumstances) is the best method for resolving a dispute in the current economic climate. In particular:

  • If the relevant contracts provide for litigation, consider the benefits of a submission agreement by which the parties can instead agree to submit their disputes to arbitration, which has the following advantages over litigating before the counterparty’s courts:
    • The parties have control over the selection of the decision-maker and the procedure, which can result in a dispute resolution framework that is tailored to the specific characteristics of the dispute.
    • Arbitrators with experience in the hospitality sector and with the governing law can be appointed.
    • Arbitration proceedings are generally faster and less expensive than litigation, particularly considering that national courts will be experiencing a significant backlog in the coming months and years.
    • The proceedings can be kept private and confidential in arbitration.
    • It is generally easier to enforce an arbitral award, compared to a national court judgment, in a foreign jurisdiction.
  • Ensure that the submission agreement is valid and enforceable by:
    • Complying with any modification requirements in the underlying contract.
    • Confirming that the governing law of the submission agreement is the same as that of the underlying contract, unless there are good reasons for a change.
    • Specifying the rules of a particular arbitral institution, or, if the parties prefer the greater flexibility of an ad hoc arbitration, the agreement should provide for the arbitration to be conducted under the UNCITRAL Rules or an equivalent.
    • Specifying the number of arbitrators (one or three) and the language of the arbitration.
    • Choosing the seat (i.e. legal place) of the arbitration, which should be an arbitration-friendly jurisdiction which is a signatory to the New York Convention for the enforcement of arbitral awards.
    • Ensuring that the arbitration submission agreement is executed by an authorized representative with proof of the necessary legal or statutory authority to agree to arbitrate the dispute covered by the submission agreement.
  • Consider mediation, either as a prior step or alternative to arbitration, which:
    • Is generally quicker and cheaper than both litigation and arbitration.
    • Can lead to a narrowing of the dispute so that, even if it proceeds to arbitration, the arbitration can be more cost-efficient.
    • Is well-suited to the preservation of an existing commercial relationship such as that between owner and operator, even if the mediation does not lead to a settlement.
    • Although a mediator cannot impose a resolution on the parties, any settlement agreed by the parties through mediation may be enforceable pursuant to the UN Convention on International Settlement Agreements Resulting from Mediation (the Singapore Convention).2
  • If the dispute is submitted to arbitration and the current operational and cash flow pressures demand a quick and cost-effective resolution of the dispute, there are mechanisms to achieve this, including:
    • Modifying or waiving any contractually stipulated pre-dispute steps such as a defined period of good faith negotiations.
    • Reinforcing pressure to settle through well-argued legal submissions which illuminate the risks an opponent faces, as well as incisive document disclosure requests, the imposition of injunctions and freezing orders, and the careful selection of arbitrators and experts.
    • Agreeing that a single arbitrator could be appointed rather than a panel of three (although it is best to have three arbitrators for high value, complex or "bet the company" arbitrations).
    • Bifurcating a case into discrete issues for determination (usually jurisdiction, merits and quantum), which can allow the parties to either dispose of the entire case at an early stage or narrow the issues in dispute and thus increase the chances of a settlement.
    • Using any available expedited procedure in the applicable arbitration rules to shorten the time-frame of the dispute, though the arbitration will still need to be carefully managed by the arbitrator(s) to ensure it finishes within the stipulated time-frame (usually six months).3
    • Disposing of spurious claims or defences that are "manifestly without merit" or "manifestly outside the jurisdiction of the tribunal" through any summary judgment mechanisms in the applicable arbitration rules.4
    • Using interim relief procedures, including emergency arbitrators, to preserve the parties’ underlying business and increase the chances of a negotiated settlement.5
    • Virtual hearings, which can circumvent travel restrictions and significantly reduce time and costs, and are particularly well-suited to disputes involving little or no witness testimony.
    • Modifications to "typical" arbitration procedures, such as limiting the number of legal submissions the parties may make (one round of submissions might suffice rather than the two rounds which are normally used in international arbitration); fixing page limits on written submissions; agreeing to limited or no document production, dispensing oral hearings in favour of a documents-only arbitration; dispensing or limiting the number of witnesses (fact or expert); limiting the length of any oral hearings, including the time for cross-examination of witnesses and experts; and forgoing post-hearing briefs.
  • Whether or not cash reserves are low, businesses may also consider the use of third-party funding provided it is legal in the relevant jurisdictions. Third party funding is a risk and cost mitigation tool increasingly used in international arbitration. When funding is obtained, the funder will assumes the costs of the arbitration (or litigation) in return for a share of any damages awarded if the claim were to succeed, while it receives nothing if the claim fails. In recent times, third party funders have also started offering portfolio funding whereby a funder assumes the cost of all cases falling within agreed criteria (both as claimant or respondent), thus taking significant costs off the company’s balance sheet while diversifying the risk of adverse decisions for the funder.6
  • Businesses may also consider employing innovative means to limit the costs of legal representation, such as contingency fees, blended rates, fee estimates and fee caps, portfolio pricing, and using counsel with dedicated pricing specialists.

The coronavirus crisis needs to be met with a healthy dose of flexibility and empathy for one’s contractual counter-parties coupled with a thorough analysis of the contract and the rapidly changing legal norms.

Footnotes

1) For more details on the ICC Model Clauses, see ICC Force Majeure and Hardship Clauses (March 2020).

2) At the time of writing, 52 countries have signed the Singapore Convention (including China, India, Iran, Israel, Malaysia, Nigeria, South Korea, Saudi Arabia, Turkey, Ukraine, the USA, Uruguay and Venezuela), though only three have ratified it (Fiji, Qatar and Singapore).

3) For examples of expedited procedures, see HKIAC Administered Arbitration Rules (2018), Rule 42; SIAC Rules (2016), Rule 5; ICDR International Dispute Resolution Procedures (2014), Article E-1; CIETAC Arbitration Rules (2015), Article 56; SCC, Rules for Expedited Arbitrations (2017); ICC Arbitration Rules (2017), Appendix VI.

4) For examples of summary dismissal procedures, see SIAC Rules (2016), Rule 29; SCC Arbitration Rules (2017), Article 39; and HKIAC Administered Arbitration Rules (2018), Article 43. Furthermore, it is generally accepted that it is within an arbitral tribunal’s inherent power to dismiss a manifestly meritless claim at an early stage: see, for example, ICC Note to Parties and Arbitral Tribunals on the Conduct of the Arbitration under the ICC Rules of Arbitration (2019), paragraph 74.

5) Virtually all arbitral institutions allow the parties to seek interim relief. For examples of emergency arbitrator procedures, see ICDR International Dispute Resolution Procedures (2014), Article 6, CIETAC Arbitration Rules (2015), Appendix III, HKIAC Administered Arbitration Rules (2018), Article 23, SIAC Rules (2016), Rule 30, ICC Rules of Arbitration (2017), Article 29; LCIA Arbitration Rules (2014), Article 9B, SCC Arbitration Rules (2017), Appendix II.

6) Key arbitration markets in which third party funding is legal include Australia, Canada, England and Wales, France, Germany, Hong Kong, Singapore, Sweden, Switzerland, and various states and territories of the USA.

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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