Owners should carefully consider the legal implications of any termination and de-flagging. A wrong or poorly advised decision can give rise to significant claims for damages for illegal termination and lengthy court and arbitration proceedings. Here, senior lawyers and hospitality specialists at Baker McKenzie, Keri Watkins and Khaled Zowayed share their expertise.
A well advised, and carefully planned termination strategy is key to the successful termination, de-flagging and rebranding of a hotel. Owners should never embark on this journey without having first sought detailed legal advice. In many circumstances, a sensible, adult conversation with the operator forms an essential element of this strategy and may result in a practical solution that allows both owner and operator to address their respective concerns and thus avoid the need for unnecessary conflict and cost.
However, achieving this type of outcome depends on a thorough understanding of the psychology and modus operandi of the operator concerned, how they have behaved in previous terminations and an assessment of the possible scenarios and how to manage those possibilities in advance of them arising.
The agreements governing the relationship between the owner and the operator will typically address the circumstances within which the owner and operator can terminate their relationship. Most hotel management agreements in the region have very limited termination rights in favour of an owner. While this recommendation appears obvious, we cannot overemphasise the importance of carefully reading the signed agreements between the parties before making any decisions.
Performance tests are one of the first logical areas to look when an owner is considering terminating its relationship with an operator. While performance tests seem appealing by title, in reality, most performance tests are very difficult to fail. This is because performance tests are usually formed of two parts, one tied to budgeted gross operating profit and another tied to revenue per available room compared to a set of competitive hotels, and failure of the test must be in a number of consecutive years. Further hindered by cure rights, these tests are effectively moving targets and tests are likely to not be applicable if there was a force majeure event in the market. There are however sometimes better negotiated performance tests that are of substance, and these may provide recourse to an owner in a way that more standard tests do not.
While some management agreements include a pre-agreed sum of damages in the event of termination without cause, most agreements do not. In the latter case, this does not usually mean that there are no damages payable but actually that a wronged party may be able to claim damages in the amount of the full fees they would have received had the agreements not been unlawfully terminated, and given the long term nature of these agreements, this can oftentimes be a very large amount that owners had not contemplated. The governing law provision is also a key consideration when quantifying damages as different jurisdictions have varying positions on the ability to award damages for future economic loss.
Tortious interference is a legal concept that provides a course of action against a party that intentionally damages a contractual relationship between two parties. In the context of a termination and rebranding, particularly where a well advised international operator is the incoming operator, new operators are likely to not want to manage a hotel until either a clear amicable settlement has been signed with the outgoing operator or any court proceedings have ended. This is because the incoming operator may carry the risk of being sued by the outgoing operator for tortious interference. As a result of this, owners that unlawfully or even lawfully terminate an operator, can experience significant delays before they are able to appoint a new operator for their hotel.
Flip to franchise?
We have seen a number of owners recently considering converting their management agreements to a franchise. Owners must carefully consider this change as it is a material change to the way in which the hotel is operated. The onus of performance flips onto the owner and the obligations in a typical franchise agreement are not easy to perform for an owner that is not experienced in managing hotels. Additionally, hotel operators are unlikely to accept offering a franchise to an owner that does not have experience in managing hotels.
Cost of rebranding?
While this is not necessarily a legal consideration, owners must carefully consider the costs associated with rebranding a hotel. We have often heard about situations where the costs of rebranding have been so high that the bene t from appointing what the owner hopes is an operator that generates more revenues and profits are significantly diminished.
Any rebranding exercise will need to give special consideration to the hotel employees in the hotel, and strategies should be adopted to motivate and retain this core element of the hotel operations to ensure a smooth transition. The legal employment contract must also carefully be considered. It is more often the case in the region that employees are sponsored by the owner, but key employees might sometimes be on secondment from the operator.
Continuity of employees is an important consideration to achieve continuity of operations.
Bookings and guest data taken by the outgoing operator and whether or not these are the property of the owner or operator must be carefully considered. There are local law considerations depending on the jurisdiction as well as the importance of considering the management agreement between the parties in this regard.
Hotel owners will need to begin talks with their lenders to agree the appointment of alternative operators. Complex and disruptive outcomes can arise if the lenders are not on board and actively engaged in any rebranding process. Additionally, the existence on signed non-disturbance agreements between the operators and banks might add additional layers of complications that need careful consideration.