Hospitality + Leisure Trend Watch April 10, 2019

Seeing into the Future – Tips for Negotiating Long-Term Brand Hotel Management Agreements

For many hotel operators, one of the most critical components that makes a management engagement valuable is the length of the management contract’s term. Management companies seek long-term contracts not only to build brand value and predictable income streams, but also to provide stability and continuity for individual hotels by establishing consistent brand presence in a market and a longer runway to stabilize an asset and maximize profitability. It is not uncommon for brand operators to push for term lengths (including extension terms) in excess of 20, 30 or even 50 years. While such lengthy terms are intended to produce economic benefits for the hotel operator and the hotel owner, they also present the unique challenge of negotiating a contract today that must withstand the test of time – a contract that adapts to and evolves with changes directly impacting the hotel asset and, more broadly, changes in the global market. While a hotel management contract need not be a work of science fiction, this article will focus on two key topics to address when negotiating management agreements with lengthy terms – competitive restrictions (areas of protection) and complications from evolving technology – to ensure that a management agreement rolls with (rather than needing to get with) the times.

Competitive Restrictions and Areas of Protection:

Many owners require a noncompetition restriction in their HMAs that prohibit an operator from operating a hotel under the same brand in the market area of the subject hotel. Often referred to as an “area of protection” or “AOP,” it establishes the geographic area in which the operator is prohibited from managing (or licensing) another hotel under the same brand. In denser urban cores, an AOP may proscribe a radius around the hotel (i.e., an operator is restricted from managing another property within 2 miles of the subject hotel) or set specific boundaries (e.g. Pacific Street to the west and Atlantic Street to the east). In other markets, the AOP may include an entire city, region or geographic area. While the area encompassed by an AOP is unlikely to change in unexpected ways in the short term, in the long term, cities can expand their boundaries, areas previously never considered for hotel development may become hospitality hotbeds, or population centers can shift. Such changes can cause an AOP that was once narrowly tailored to expand beyond what an operator originally intended, with the consequence that the operator will be more restricted from exploring new business opportunities than it expected.

The inverse is also true. An owner may have felt protected by a radius restriction or geographic description that encapsulated the urban core of a city (e.g. the downtown central business district), but as that city expands and shifts, the owner may find its asset is not adequately protected decades later. As an example, the explosive growth in downtown Los Angeles would have been hard to envision in the 1980s (and even into the early 2000s), but this area of the city now serves as a business, entertainment, lifestyle and housing destination, and correspondingly, requires hospitality products.

To protect against being excluded from future markets, a hotel operator should address the AOP with as much specificity as possible. AOPs that encompass an entire city should be considered carefully – a city may grow over time (as in the case of Los Angeles), or the very boundaries of a city may not have a precise definition (e.g. an area may be known colloquially by a certain name, but such name may not have any legal significance). Where a restriction is tied to a radius from the hotel, it is helpful to depict the AOP on a physical map to determine the entirety of the area falling within the radius – the act of visualizing the AOP may provide insight as to locations that are likely to experience population growth or shifts in the coming decades. Further, best practices call for plotting an AOP on a map (and referencing that map within the management contract) so as to eliminate any ambiguities that may be created by only including a literal description of the AOP. Where an AOP is somewhat amorphous or too large to show with specific detail on a map, including GPS coordinates can help lock in the boundaries today so that an operator does not find itself locked out of future markets, or an owner does not find itself with a competitor hotel in closer proximity than it had anticipated. Lastly, parties should contemplate “time-stamping” the AOP (i.e., describing the coverage of an AOP as it exists on a certain date) to serve as a reference point in the event an AOP dispute should arise in the future.

While the physical boundaries of an AOP are important, so are the restrictions an AOP might impose on the activities that an operator may or may not perform within the AOP. With an eye toward current industry trends of brand consolidation and soft brand proliferation, an unintentionally overbroad AOP could forestall future opportunities for an operator, or at least put the operator at risk for claims by owners that it has violated the AOP by virtue of its acquisition or merger with another operator. Attention should be paid to the party restricted by the AOP (i.e., is it just the party to the management contract, or does the AOP extend to affiliates?) and, relatedly, whether the AOP applies only to a particular brand name (or, could it be read to include other brands controlled by the operator’s parent or a yet-to-be-developed sub-brand?). In addition, with the rise of the sharing economy and the advent of alternative lodging experiences, even the definition or use of “hotel” should be scrutinized so as not to unintentionally handicap growth in unknown or future lodging offerings and products.

Technology:

Predicting how a city may be transformed over the course of several decades is far less complicated than making even the most basic predictions as to where technological advances will lead us in the coming decades. How much of a hotel room, the guest check-in experience or guest-employee interactions, as we think of them today, will be recognizable in 25 years? Will parking be a necessity in a world driven by autonomous vehicles? What technology will be used to market to guests 20 years from today? Certain trends are already taking shape with the proliferation of technology in our lives and are having, or will have, direct impacts on hotel staffing.

As smart phones have turned into room keys, the traditional front-desk “experience” is rapidly evolving, and with it comes a decreasing need for large front-desk teams. Improvements in telecommunications and cloud-based networks have allowed hotel companies to centrally locate many hotel management functions that previously were performed on-site (e.g. revenue management and accounting) and which can be performed by the same corporate personnel across multiple assets, rather than being performed by individuals located in a specific hotel. While each of the above can lead to a reduction in operating expenses and other efficiencies at the property level, they also effectively shift responsibilities from the hotel to corporate offices. As more “corporate” personnel perform what were previously local tasks, the universe of employees for which the operator is accountable expands. With this expansion, the risk (and possible quantum) of loss, for both owners and operators, also grows, while the ability of owners and operators to isolate this risk decreases. Hotel brands and owners will want to specifically review indemnity provisions, especially as they delineate between actors which constitute “manager” and those that constitute “hotel personnel” in order to ensure the indemnity net is cast as broadly (or narrowly) as the owner’s and operator’s respective interests dictate. As traditional hotel functions become more internalized and centralized, the push and pull between owners and operators to allocate costs and risks appropriately will require new thinking and prescience.

Further, as front desks become anachronisms or back-of-house facilities become smaller with fewer tasks being performed on-site, valuable real estate will be freed up for other uses. On the one hand, the brand may try to “hold” onto this space by relying on its ability to control hotel amenities and features through brand standards. On the other hand, the owner may see opportunities to monetize the new space by repurposing such space for revenue-generating uses, such as meeting space, retail shops, or food and beverage outlets. How this newly “found” space comes to be used may depend largely on the relative negotiating positions established by an outdated management contract.

With the only certainties being that innovation will not stop and hotel guests will demand the latest and greatest, a management contract cannot (and perhaps, should not) address the unknown future with any specificity. Instead, operators and owners should focus their negotiations on retaining flexibility to accommodate technological change in whatever shape it may take.