Standard Form of Hotel Management Agreement 2008 Annotated with Introduction. K.C. McDaniel K.C. McDaniel PLLC Brooklyn, New York

Transcription

1 909 ALI-ABA Course of Study Modern Real Estate Transactions: Practical Strategies for Real Estate Acquisition, Disposition, and Ownership July 29-31, 2010 Chicago, Illinois Standard Form of Hotel Management Agreement 2008 Annotated with Introduction By K.C. McDaniel K.C. McDaniel PLLC Brooklyn, New York 2009 K.C. McDaniel. All Rights Reserved.

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3 911 Current Issues in the Negotiation of Hotel Management Agreements 2008 With new hotel development and investment at a halt, the hotel industry is focused on existing management agreements as important elements in the success, failure or restructuring of hotel investments and loans. The management agreements currently in negotiation will be short term, providing for interim management for failed hotels. How existing management agreements impact loans and investments over the next months and years will dictate how management agreements are approached when new development resumes. Management agreements and how lenders and owners view such agreement underwent many changes in the last decade. To understand how management agreements may be negotiated in the future, what parties accepted in 2007 or 2008 is largely irrelevant, as is what lenders currently accept in their negotiations. What is relevant, and on what the industry has begun to focus, is what owners, lenders and managers are disputing. These disputes reflect issues that are emerging as not adequately addressed in the current management agreements or as addressed improperly, in the view of lenders and investors. And there is no doubt that sources of capital will dictate the parameters of the next generation of management agreements. As background to a discussion of the topics and contract provisions currently in dispute with managers, it should be noted that there have been a number of significant legal developments since the last downturn and changes in the management agreements intended to address these. Looking back over the last 15 years, the most significant cases include: Government Guaranty Fund v. Hyatt Corporation, et al. 1 This case arose as a dispute between Hyatt Corporation and the owner of a newly opened Hyatt hotel in the Virgin Islands. After the owner s failure, the owner s position was later taken over by its lender and subsequently by the lender s regulatory insurer, a foreign bank guaranty fund analogous to the FDIC. The guaranty fund took over the bank upon its failure during the dispute. The case had two major phases. First, the guaranty fund sought to terminate the management agreement at will under principles of agency law. The guaranty fund ultimately prevailed in this when the Third Circuit Court Of Appeals confirmed the right of an owner, whether an original owner or a successor by foreclosure or by deed in lieu, to terminate its managing agent at will, subject to a possible claim by the agent for damages for early termination. This decision in 1996 was widely noted and substantially reshaped the playing field for managers of hotels. The decision was read to put the management companies at risk of immediate termination by their principals if there was a breakdown in their relationship. Second, the case was then remanded from the appellate court to the trial court. What happened on remand was minimally reported. Hyatt was found to have intentionally withheld substantial evidence concerning, inter alia, its practices in regard to vendor payments. This resulted in, among other things, a finding of contempt and imposition of sanctions against Hyatt and certain of its representatives. The case ultimately settled without a reported decision. 1 Appeal reported at 95 F.3rd 291 (3rd Cir. 1996).

4 Woodley Rd. Joint Venture v. ITT Sheraton Corp. 2 Through a coincidence of the assignment of the Virgin Islands to the jurisdiction of the Third Circuit Court of Appeals, the decision in Government Guaranty Fund v. Hyatt came to apply to the jurisdiction of Delaware, creating a potential for cases involving Delaware corporations or limited liability companies to be decided under that precedent. Woodley Road was such a case, tried to a jury in a Delaware federal court. The court was the first to apply the Government Guaranty decision to authorize the early termination of a hotel management agreement without cause under agency principles. The case then continued through a jury trial of claims of mismanagement and breach of fiduciary duty, and resulted in a substantial verdict against Sheraton (offset to some degree by a malpractice settlement with its trial counsel). Much of the evidence against Sheraton involved solicitation and acceptance of kickbacks from vendors permitted by Sheraton to do business sometimes as an exclusive vendor -- with hotels managed by Sheraton. The Woodley Road case is generally regarded as the case that linked the possibility of at will termination with the risk of liability for brand-wide practices such as the solicitation of rebates from vendors given the right to deal with the brand's hotels. Many of the preferred vendor rebates had been undertaken in the belief that, at worst, the rebates might have to be disgorged. Because the brand groups controlled all of the information on these kickback arrangements and were prepared to grind owners down with delay and expense while the management fees continued to be paid, they saw little risk and substantial potential profit. Woodley Road pointed out a greater risk that a brand management company could be immediately terminated by a suspicious owner who would then pursue its damage claim. If the facts ultimately revealed misconduct by the management company, it was not only liable for what it had accepted from the vendor but, in many important commercial jurisdictions, for all amounts it had taken during the term and for punitive damages for breach of fiduciary duty. Woodley Road set off alarm bells throughout the management companies. The case led directly to changes in the operation of many brand groups, as well as to attempts to change the law by statute, to obtain waivers of agency obligation, and to insulate the management companies from the risks of jury trial and punitive damages. Among the changes sought by some management companies were the insertion in contracts of disclaimers of agency, expanded use of mandatory arbitration clauses, and attempts to conceal or launder kickbacks, hidden profits, income from frequent traveler programs, kickbacks and similar types of indirect profit to avoid claims by owners. CTF Hotel Holdings, INC., v. Marriott International, Inc.; Renaissance Hotel Operating Company; Avendra L.L.C. Marriott International, Inc., Renaissance Hotel Operating Company 3 This dispute resulted in two related cases, one in federal court in Delaware and the second sent to arbitration. Both involved portfolios of Renaissance-branded hotels, for which the right to manage wad been sold to Marriott International in the late 1990s's. This dispute involved claims by the owners of the hotels about how their hotels were operated after the management was acquired by Marriott. While the federal court case was resolved by settlement, it attracted substantial attention in the financial and industry press when the cases were filed and again when JJF (U.S. Dist. Ct. Del. 2/4/98). Appeal reported at 369 F.3d 732 (3d Cir. 2004). 3 D. Del. No and No Appeal reported at 381 F.3d 131 (3d Cir. 2004).

5 913 the settlement was reported. The case was noted for the issues of the impact of brand-wide management practices on a portfolio, and in particular the issues arising in the operation of Avendra LLC, an entity established by Marriott and Hyatt after the appellate decision in Government Guaranty. Avendra LLC was inferably designed to continue the collection of vendor payments previously paid directly to affiliates of the brand groups in consideration of the ability to sell goods and services to the hotels that the brand-affiliated managers controlled. CTF was the first case to point out in a public filing the complexity and scope of the methods by which brand groups had redirected their business to take profits from hotels that were not aligned, and indeed were in conflict, with the profit goals of owners. The agreements at issue in these cases were created in the 1980 s and 1990 s. Management agreements have since undergone many changes, some reflecting the evolution of capital markets but most driven by specific business plans of the brand groups. Twenty-five years ago, much of the investment and hotel projects came from large institutional investors, insurance companies and pension funds, and public investment in conglomerates which included subsidiaries that owned and operated hotels. Hotel brand groups were substantial investors in the hotels that carried their names. Limited partnerships created as tax benefits and syndications fueled new development, in which brand groups profited as managers and providers of brand names and services but had little or no investment. By the late 1980s, the market for hotel investment had changed. Tax syndications had ended as a result of federal tax reform, requiring investment to be based on cash returns. Regulated institutional investors had been permitted a broad expansion in the types of investments they could make, and were much less focused on hotels. The large airline and corporate groups that had owned the major hotel brand groups began to spin off the ownership of brand franchise and management businesses into new public companies and, separately, to sell off the equity ownership of hotels. Real estate investment trusts, private venture funds, sovereign funds and hedge funds fueled new development and, by a demand created for opportunities for equity investment, an increase in values for hotel properties. Securitized mortgage and mezzanine lending drove activity and valuations to even higher level, as rating agencies facilitated higher levels of leverage and seemingly cheaper debt. Brand groups were increasingly stand-alone public companies, aggressively seeking increased earnings and stock price improvement with minimal risk. In this environment, brand groups and in particular brand groups as luxury managers were able to obtain advantageous terms not previously seen in the hotel industry. These terms, and in particular the provisions entrenching brand-affiliated management and purporting to allow such managers to disclaim fiduciary duty, are now being tested in negotiation, litigation, and other venues for alternative dispute resolution. The terms are potentially at issue in literally thousands of hotel loan defaults and workouts now underway, and the stakes are very high. We are now entering a new period of intense scrutiny of management agreements and practices, and not solely or even primarily because of the economic downturn. Many of the matters now in dispute surfaced as issues well before the downturn, and some issues date back more than a decade. The increased pressure on the profits of hotels and impending debt maturities have changed mediocre or unsatisfactory performance into disastrous failure, just as brand groups are seeking to replace lost income or increase their own revenue to meet their own obligations. Owner and lender frustrations and disappointments have now become crises, in direct collision with management companies business plan. Many of the current disputes seem to arise in the steps taken by brand groups to elude the impact of Government Guaranty, Woodley Road and CTF. When management companies realized the implications of those cases and other cases that descended from them, some management companies simply choose to cease taking hidden profits or to make full disclosure to owners and reach agreement on if and how the profits would be shared. But other companies viewed the profits derived from those programs as so significant to their businesses that they seized instead upon the strategy of continuing the practices indirectly and by other means. Some companies sought to eliminate references to agency in their forms of management agreement, or to obtain waivers of agency-related obligations without fully pointing out to owners what they had been doing and hoped to continue to do. Some recharacterized the kickbacks, which had already been repackaged as rebates, into sponsorships or strategic marketing relationships. The changes concerned form and not substance. Some companies also sought to protect