> Management Agreements

Management Agreements

As far as I can tell, the agreements that owners sign with hotel management companies are unique to our industry.  They are frequently misunderstood, not only by those who have no previous knowledge of such agreements, but even by those who sign them!

In a nutshell, the owner of a hotel invests his money to create the physical structure, the building, pays fees to the management company for their advice on the design and the application of brand standards, provides the working capital, and then hands over the property to the management company (also known as “the operator”) to create and build the business.  All the risk lies with the owner, and with the lenders to the owner, with zero risk taken by the operator.

On the face of it, that sounds like a one-sided deal, doesn’t it.  Well, yes, the agreements are typically very one-sided, some more so than others.  What has happened over the years is that the management agreements that each chain signs has evolved – every time an event occurs which the operator believes is detrimental to the smooth running of the hotel, or which has a negative impact on their brand, a clause gets added to the standard agreement template stating that such and such an occurrence would result in the owner being in breach of contract, and is therefore not permitted.  The agreements are nearly always originated by the hotel chain, and as time goes by fewer and fewer of the clauses are negotiable – it really does become a take-it-or-leave-it scenario.

The result is an agreement which can come across as extremely arrogant  - kind of “build me a hotel to my specifications, then give me the keys, go away and stay away – but be there whenever I need more money”.

Why would any owner agree to such a contract?  Well, the answer is quite simple – it is because they cannot manage a hotel as well as the chains can.  And why have the hotel chains developed such “aggressive” management agreements?  Because what the operator wants is to be left to manage the hotel for the life of the agreement, without interference from the owner, or from third parties.  And why don’t the hotel chains invest in the hotels they manage? Because (with some exceptions) that’s not what they do, they manage hotels on behalf of owners who want to benefit from their branding and their expertise and have, historically, had no shortage of owners willing to sign up to that.

I often write and speak about the number of new deals that the hotel chains are signing in Africa – according to our latest pipeline survey, the chains have 215 hotels due to open, the vast majority of which are management agreements.  The rest?  There

are one or two leases, where the hotel chain pays a rent as if they were leasing a shop, and one or two franchises, where the owner manages the hotel himself, but uses the chain’s brand.  Both are still quite rare in Africa, outside of South Africa – the chains want to manage rather than franchise, because then they are in total control, and they don’t like leases, because of the risk and balance sheet impact involved.

One of the features of African hotel development is that a large number of the deals that have been signed are with first-time hotel owners, who therefore have no real experience of how the industry works, and certainly no idea of how hotel chains and their management agreements work.  Which is why there can be so much resistance to some of the fundamental terms of contract, such as:

  • a management company will take a two part fee, a base fee calculated as a percentage of revenue (normally up to 3 per cent), and an incentive fee calculated as a percentage of gross operating profit (“GOP”, which is defined in the “hotel accounts bible”, of around 10 to 12 per cent. Owners sometimes have difficulty understanding why the management company should take a fee based on revenue, when there may be no profit – the operator gets paid and the owner receives nothing.  There are two answers to that, one that this is how the industry works, and the other that the chains are providers of a service to the owner, and should get paid.  Further, the structure of the fees is that the chain is incentivised (hence “incentive fee”) to make a profit for the owner, and takes a share of that profit.  They are interested both in maximising revenue and minimising operating expenses, and are not interested in running unprofitable hotel.  It is a structure that works.
  • The operator will insist on exercising total control over the cash flowing through the business. The only signatories to the bank accounts are those designated by the operator.  This I have found one of the hardest clauses for new owners to accept, simply because they have never done it before in any of their other businesses.  I have seen a deal collapse on this, everything else was agreed, but the owner insisted on controlling the bank account, and the potential operator walked away.  Why do the operators insist on this?  Because the cash flow is the life blood of the business, and both their brand name and the sustainability of the business is at stake if they are unable to deliver on their brand promises, which may be the case if the owner leaves them short of cash.
  • Whilst the owner gives up total control of the business to the operator, the operators take no responsibility for the actions of the staff of the hotels they manage. The employees of the hotel are legally the employees of the owner (not the hotel chain), those employees are hired, trained and supervised by the hotel chain, but the owner is responsible when things go wrong.  Their argument is normally that they are simply a service provider, and are not sufficiently remunerated to take any liability.
  • The owner is placed under various restrictions regarding who they can sell the hotel to, with the operator having a veto. The reason given by the operators is

that they have signed a long-term agreement with a particular owner, and there are various parties who, if they became the owner of the hotel, they do not want to do business with (e.g. other brands) and in many cases cannot do business with (e.g. Sanctioned Persons, ex-criminals).  We have in most cases been able to remove from the agreement the total veto right of the operator in the event of a planned sale by giving the operator the right to match any offer received for purchase of the hotel, as well as by tightly specifying the classes of prohibited purchaser.

  • Measuring the performance of a hotel operator is very difficult, and many owners will complain about their inability to remove a management company who is not performing. This is very true, as there will always be reasons put forward why the budget has not been met, especially external impacts on a hotel’s business which will cause, normally temporary, reductions in occupancy and therefore profit.  Performance clauses can be added into agreements, but they are nearly always unenforceable, simply because of the same problem, that of defining and measuring the benchmarks to be used.

I mentioned above “long-term” agreements.  The norm these days is for a management agreement to have a term of 20 or more years with, in some cases, 30 or more.  Longer than many a marriage!  No wonder they are extremely detailed documents, with the two parties agreeing for an extremely complicated business to be created and run for that length of time in an extremely complicated building.  Some management companies I deal with have a set of no fewer than six agreements that an owner must sign - pity the poor hotel consultant that has to read every word of every one, and advise his client!

Seriously though, it is essential for an owner who has little or no prior experience of these agreements to get expert advice – and that means expertise in the hotel industry, and of these types of unique agreement.  All too often I deal with lawyers who have never seen a hotel management agreement before, and with gusto try to change every clause, in the mistaken belief that the hotel chains are going to roll over and allow that.  It ain’t going to happen, and the relationship will start off on the wrong foot.

Yes, hotel management agreements are one-sided in favour of the operator, but remember that the hotel chains have the same objective as the owner, which is to build a sustainable business over the long term, and to generate superior returns for both parties.  To repeat, the management agreements being negotiated in Africa include the self-same  structure that works worldwide, and owners should embrace it, from a basis of knowledge and expertise.

Trevor Ward

W Hospitality Group, Lagos


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