All things shall pass including hotel management agreements

By Sumes Dewan and Tanya Mishra, Lex Favios

Hotel management agreements (HMA) usually set out the circumstances in which hotel owners and operators may terminate them.

Prescribed events may allow the termination of an HMA by a hotel owner. These include such matters as the mutual agreement between the owner and operator; the operator failing to achieve agreed levels of performance; the operator causing a material or major breach of the HMA; the operator committing fraud or misappropriating monies; the operator causing a sale or withdrawal of its brand, and the operator causing or permitting damage to or neglect of the property.

Sumes Dewan, Lex Favios
Sumes Dewan
Managing partner
Lex Favios

It is essential the HMA contains well-defined performance metrics that protect the owner against operator non-achievement. Such standards should measure the performance of the hotel to assess the operator’s value. The owner must have the right of termination where the operator fails the performance test, whether or not the operator has a right or is able to cure the failure. The profitability of the hotel is the best measure of performance.

The performance test should exempt the operator from liability for external circumstances beyond its control that adversely affect a hotel’s performance. In such cases, an operator will usually demand that the HMA contains a right of payment to cover the shortfall between the actual performance of the hotel and that required in the HMA.

Events that allow termination by a hotel operator include the owner’s material breach of the management agreement; the owner’s failure to provide sufficient working capital; transfer of ownership of the hotel; the bankruptcy of the owner, and the owner causing or permitting damage to or neglect of the property.

Material breach by either party of one or more of its obligations under the HMA usually enables the non-defaulting party to terminate by issuing a termination notice. Most HMAs specify a period during which the defaulting party can cure the breach. Additionally, there may be an obligation on the parties to take part in a consultation process through their respective executive managements, during which the parties try to remedy the situation.

Tanya Mishra, Lex Favios
Tanya Mishra
Head of the
corporate practice
Lex Favios

In cases where the hotel has been neglected, damaged or destroyed, thus preventing or disrupting operations by the operator, HMAs usually contain a provision allowing either party to terminate the agreement. The question that then arises, in the absence of total destruction, is whether the amount of damage is such as to trigger termination or an obligation on the owner to repair such damage.

The capital needed to run and operate the hotel is provided by the owner. However, most HMAs provide for the operator to control the hotel’s bank accounts, through its authorised signatories. This allows the operator to manage the hotel properly by being able to pay operating expenses. The operator should, however, be required to obtain the approval of the owner to pay for expenditure over a prescribed amount.

The operator is not responsible for providing working capital for the hotel. All such capital has to be provided by the owner. If the owner fails to supply working capital when requested to do so by the operator, it will usually be a breach of the HMA. This will then allow the operator, after the expiry of any contractual grace period, to terminate the HMA.

Bankruptcy of either party will usually provide the other with a specific right of termination. An operator in particular will demand a right of exit in such a situation to disassociate itself from the hotel and any damage to its reputation. This will protect the operator’s own brand value and reputation.

HMAs deal with the bankruptcies of owners, which are treated as defaults entitling the operators to damages. However, this has not been tested under bankruptcy law in India. In the bankruptcy of the corporate debtor, that is the owner company, the sale of assets may not lead to damages for the operator, as the operator would only be an unsecured creditor. In the absence of a non-disturbance agreement, the resolution process is under no obligation to honour the HMA or pay damages to the operator.

This analysis of the rights of owners and operators shows that the issue is the extent to which HMAs impose liabilities and thus allow termination. In practice, termination clauses usually give owners far less opportunity to end HMAs than they allow to operators.

Sumes Dewan is managing partner and Tanya Mishra is the head of the corporate practice at Lex Favios.

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