Australia: "No Vacancy": Negotiating Management Contracts In The Current Market

Last Updated: 26 September 2009
Article by David Wilkie and Tom Nguyen

Key Points:
The current environment allows parties to implement creative structures under Hotel Management and Operating Agreements, with enough flexibility to take advantage of the market when it inevitably turns.

It's a catchphrase most of us are no doubt thoroughly sick of hearing, but flick through any newspaper, industry magazine or publication such as this and it is hard to escape those three words: global financial crisis. The GFC, as it is affectionately known, has affected every industry one way or another, and Australia's hotel industry is no exception.

But it's not all doom and gloom. The word on the street is that the hotel industry is picking up pace as cashed-up international and domestic investors trickle back into the market, while at the same time, hotel owners (particularly owners of mid-range hotels and motels) are seeking experienced and well-branded operators to steer their investments through these choppy times.

Negotiating Hotel Management and Operating Agreements – trying to get the upper hand

It is fair to say that the hotel industry has undergone significant change over the last 12 months, particularly in the way hotel owners and hotel operators approach the negotiating table. While each party's respective agenda is not dissimilar to that which they brought to past deals, it is clear the market has forced them to take a more silo-like approach to protecting their position.

While each party's aim, understandably, is to negotiate the best possible deal, it is important both parties appreciate that they have a common goal – seeing the hotel succeed. Financially, both parties receive a share of the profits, but separately the hotel owner will endeavour to increase the value of its asset while the hotel operator will aim to increase its brand recognition and reputation. Therefore, more than ever, it is important the parties put in place a balanced Hotel Management and Operating Agreement that represents a "win-win" for both.

Hotel Management and Operating Agreements are never straightforward. We have set out below our understanding of the current key negotiation points in Hotel Management and Operating Agreements.

Term of the agreement

While Hotel Management and Operating Agreements historically have contained long terms with options for renewal, especially at the top end of town, we are now seeing shorter terms being entered into to allow both parties to reassess their respective positions much sooner – and if required, walk away from the arrangements. For global brands, a 10 year term with one or two five year options is common in the current environment.

Previously, Hotel Management and Operating Agreements were also usually drafted in favour of hotel operators, especially the well-known and reputable operators who could throw their weight around. This included options to renew the term of the Hotel Management and Operating Agreement at the sole discretion of the hotel operator. More recently however, there has been an increasing shift towards renewals being:

  • mutually agreed by the hotel owner and hotel operator; or
  • exercised at the option of the hotel owner rather than the hotel operator.

This shift in power illustrates that the parties' bargaining positions are now generally even.

Management fee

There are two main components to management fees, namely:

  • a base fee, and;
  • an incentive fee.

The base fee is usually a percentage of the audited gross revenue while the incentive fee is a percentage of the audited gross operating profit.

Base and incentive

We are currently seeing that hotel owners are seeking to remove or reduce any base fee in exchange for a higher incentive fee. The percentage of the incentive fee largely depends on:

  • whether a base fee is paid and if so, the amount; and
  • the reputation of the hotel operator and the market standing of the hotel and the hotel operator.

The main reason for hotel owners seeking to remove or reduce the base fee is (1) to ensure that the hotel owner is not paying a high base fee when operating costs are high or where the hotel is running at a loss; and (2) to incentivise the hotel operator to achieve a higher gross operating profit. While this is also beneficial to the hotel operator as it receives a higher incentive fee, nervousness and unpredictability in the current market have resulted in hotel operators being reluctant to agree to this payment structure.

In today's market, it would not be surprising if hotel operators started seeking higher base fees but maintained a reasonable incentive fee. It is unlikely this would be well received by hotel owners unless this payment structure was to operate for a short period of time or unless there was a mechanism where the payment structure would change (for the benefit of the hotel owner) if certain milestones were reached (for example, there was a percentage increase in the gross operating profit).

Rates

Recently we have witnessed tension between hotel owners and hotel operators over room rate charges. Both would like the hotel to be at full occupancy, but the question is, at what cost? In today's market, hotels are facing an uphill battle when trying to fill rooms, with fewer people travelling and other hotels slashing their prices to get what business there is. While reducing rates will attract visitors and may increase market share, hotel operators face an increasing dilemma. They face pressure from hotel owners to fill rooms, but in slashing rates they may:

  • tarnish the hotel operator's image and brand (especially hotels at the top end of the market), and;
  • make it difficult for the hotel operator to charge the standard rate once the economy turns around and demand picks up.

To remove this tension, hotel operators are usually given the right to set the room rate charge but subject to the overall budget setting, an approval process and various financial performance targets as set out below.

Financial performance protection

Income guarantee

Due to the GFC, hotel owners are increasingly seeking from hotel operators income guarantees for an agreed amount and period. Where the hotel operator has agreed (usually reluctantly) to an income guarantee, the hotel owner usually has to offer something in return. This may include offering the hotel operator more control over the operation of the hotel to ensure it is not restricted in achieving its target.

Financial performance termination provision

A financial performance termination provision gives the hotel owner the right to terminate the Hotel Management and Operating Agreement if the hotel operator fails to achieve the financial performance targets for the hotel over a specified period of time. There are a number of tests that the parties can apply (these will normally not apply in the early years of the Hotel Management and Operating Agreement while the business or the hotel operator's management of the hotel is being established).

We are seeing an increasing number of such clauses to enable the hotel owner to terminate the agreement and walk away if the hotel is not meeting its financial performance targets. This may also be in the interests of the hotel operator, as not meeting such targets will affect the hotel operator's total fees and may also damage its reputation.

Lessons for hotel operators and owners

There is little doubt the global financial crisis has significantly affected the hotel industry. While there are some positive signs that the industry is emerging from the crisis, players in the market are taking a very cautious approach to negotiations. However, the current environment has also allowed parties to implement creative structures under Hotel Management and Operating Agreements, with enough flexibility to take advantage of the market when it inevitably turns.

In the meantime, it is important for both hotel owners and hotel operators to remember that negotiating and agreeing a Hotel Management and Operating Agreement requires an equal investment on both sides. Such agreements will not work unless the parties are prepared to work together to achieve their common goal – being able to put up the "No Vacancy" sign.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions