Sri Lanka: Hospitality trade throws up new legal challenges

By Mr Dinesh Munasinha

Hospitality Trade is dynamic and ever changing, and throws new challenges to the legal fraternity. The well known hospitality concepts have changed drastically over the years. In this paper I wish to discuss some of these changes.

1. Shifting from traditional lease agreements to Management Agreements - its pros and cons.

In hotel and restaurant sector, the location is important for successful marketing. Most attractive locations near the city centres, beach, river banks or archaeological sites are considered as hotspots for attracting tourists. Many hoteliers prefer to take-on-lease premises closest to such hotspots as it would be cheaper than outright purchase. The legal process is usually to draw up a Lease Agreement and register it at the land registry. With the lease, the Lessor gives up its right of possession and the Lessee takes over such property right with certain limitations such as carrying out structural changes to the premises. The Lessor is usually paid a fixed fee and the losses and profits of business are completely subsumed by the Lessee. Until the 1980s, hotel operators commonly leased hotels to expand their brands. The problem with lease model is that, Lessee is obligated to pay rents and other operating expenses, and even exposes himself to business losses and they wanted a means of avoiding these type of risks. However, the recent trend is to look for Hotel Management Agreements wherever possible.

A Hotel Management Agreement, is where the owner retains possession and property rights of the premises and invites another party to manage the business. The key difference between the management agreement and a lease in this context is that, the Manager will not have any interest on property whilst the Lessee would. The following table sets out the key differences between the two versions under Sri Lankan Law.

Despite these clear differences, certain agreements call themselves 'Hotel Management Agreements' although the substance suggest otherwise. Some even transfer possession of the premises, in which case the Courts may be inclined to say it is not a management agreement.

An interesting case which analysed the nature of contract and used employment responsibility as a yard stick is Hotel Galaxy (pvt) Ltd v Mercantile Hotels Management Limited.³ The Hotel Owner, Hotel Galaxy (Pvt) Ltd had appointed, Mercantile Hotels Management Limited as Managing Agents of the hotel for six years to manage and operate the hotel on its behalf and to engage the necessary staff. The staff were to be in the sole employment of the Hotel Owner. The Manager would receive a percentage of the gross annual profits of the hotel. The Manager during this period ejected the Owners general manager and took over the hotel. Atukorale J analysed that "The instant case is not one where possession of the hotel premises has been handed over by the 1st defendant [Hotel Owner] to the plaintiff [Managing Agent] to enable the latter to run a hotel on its own behalf or on its own right". ⁴ Hence, this was a management agreement and not a Lease where the lessee can take over possession.

The hotel management agreement creates a relationship of principal and agent. In more recent times the agreements have been drafted to specifically exclude this relationship of principal and agent and make it one of an independent contractor. This is because under the agency principle, the Principal is bound by the actions of the Agent and only recourse would be to sue the Agent for acting against the instructions of the Principal. Finnegan V Galadari Hotels (Lanka) Limited⁵ , was a case where the Agent acted against the instructions of the Owner regarding the allocation of rooms. Interestingly, in this case the allocation was done by the resident manager who was appointed by the Manager but who was salaried by Galadari Hotels (the Hotel Owner). This shows the complexities a management agreement would create. In such cases one may have to apply the tests applied under common law (control test, integration test, economic reality test etc.) to determine the employer.

As opposed to Management Agreements, the Franchise Agreements are a more loose form and one which emphasises more on the business concept itself.

2. Franchise - the new trend in brand promotion and its pitfalls

Franchising in United States of America had become one of the most favoured distribution business models which is used in more than 70 industries and is estimated to generate more than $1 trillion in U.S sales annually. However, it is relatively recent concept and somewhat less popular in Sri Lanka. Franchising is a business strategy which allows one business entity to use the logo, trademarks and operating systems of another business entity for a payment of a fee. Although Franchising is not limited to Hospitality industry, it's more widely used in this Industry. Good examples in Sri Lanka are Kentucky Fried Chicken (KFC), McDonalds, Pizza Hut, Burger King and Machang Pub Chain which are leading Food & Beverage restaurant chains. Franchisor will allow Franchisee to open a restaurant in an approved location using the Franchisor's Brand name and serve food cooked in accordance with standard recipes, and even to do the interior deco in the Franchisor's corporate colours.

In some other countries, when franchisors strive to establish and spread franchise businesses they are subjected to rigorous legal requirements. However, in Sri Lanka the laws are virtually non-existent.

3. E-branding of Hotels

In the modern day, many search the internet to plan their travel and lodging as it provides a platform to get an insight on facilities of hotels, compare prices and read reviews on experiences of other guests. Whilst websites such as tripadvisor.com, fodors.com, etravelreviews.com provides valuable information in planning the trip, some other websites such as bookings.com and agoda.com even help its visitors to do the booking in their website itself. Hence, the customers do not have the hassle of going through each individual website of the respective hotels for booking. These websites invariably provide slightly cheaper options and better promotions. For these services, the website owner charges a commission from the Hotel. For the Hotel this is a good method of marketing especially for foreign tourists. Certain issues that customers face when making an e-booking is highlighted elsewhere in this paper.⁶

However, the least discussed aspect of e-booking system is the hardships faced by the Hotels. As the popularity of e-booking websites increase, so does its bargaining power.

These web sites constantly push the Hotels to give their customers preferred treatment. Through their well-drafted standard contracts, the Hotels are made to pay extra fees or agree to reduce their search ranking on their website or even for removal of the hotel from the website altogether for not giving favored rates for their clients.⁷

4. Time Share Schemes

The notion of the term "time-share" was originally created in Europe during the 1960s. "Hapimag", a ski resort developer in the French Alps, was experiencing trouble finding customers for his high priced resort. Realizing that coffee shops sold cake only by the slice (since the entire cake was too expensive), "Hapimag" also sold its resorts in portions. The key feature of time share is that the customer purchases the right to use the property for a certain period.⁸ For example, a traveller who comes to Sri Lanka every year will book a colonial house with a great view in Nuwara Eliya for the month of April every year. This creates what is called a "time share" for the month of April each year and such traveller will be called the "time share owner". The owner of the property will charge for several years at once and make it available each year on year to this time share owner. During the remaining months the owner has the right to rent it to others, or occupy by himself or share with some other travellers for another part period.

The key feature of time share is the ability to re-sell the time slot as well. For example if the traveller cannot come in April that year, he could sell that right to any other person so that such other party can occupy the place in April.

Many countries do not have specific laws for time share schemes, whilst some countries use Deeds of Conveyance in terms of property law of that country, some other countries use commercial agreements.

The time share scheme also has its pitfalls. One such instance is where the time share user or the consumer has paid for a long period (10 years) at the very outset, and it has been reported that the manager/owner of the property has wound up the company and sold the property to a third party before the expiration of the said time period. Several incidents of this nature came to the notice of the authorities in Mexico and United Kingdom during 2008-9 era. Some other schemes have misrepresented the true value of the property⁹ whilst some other schemes have coupled them with pyramid schemes or have charged hidden additional high management fees.¹⁰

It is submitted that under Sri Lankan law, the safest option for a time share owner is to have a Lease Agreement for that particular month (or period) for over several years, which may be registered in the land registry. The main practical issue is that Sri Lankan Law requires all interest on land to be notarially executed.¹¹ Even the Electronic Transactions Act does not allow immovable property to be conveyed through electronic means.¹² Accordingly, it is arduous for the physical document conveying the time share to be signed in presence of one another when the traveller or the sub leasee is out side Sri Lanka. Hence, one of the available options would be to have a deed which is non notarial and which would fail to be legally enforceable. It is submitted that the best way to resolve these type of issues would be to recognise it in law as a special category of contracts, thereby to provide a guarantee for such occupants by controlling the method of obtaining advance payments for future years.

5. Hostel Concept re-defined

A novel version which is fast spreading throughout the world is the hostel concept.¹³ It has been revealed that many travellers who visit a city would spend most of their time outside at tourist attractive hotspots. Therefore, for these type of tourists spend very little time in the hotel or rest house. For them, lodging only for the night in shared rooms with bunk beds or other mode of shared accommodation is good enough. This comes under the category of budget accommodation and is getting increasingly popular in Sri Lanka in apartments along the western coastal belt. However, this also causes a nuisance to other residents in such apartments, as these travellers disturb by arriving at different times and occupant's sense of security is threatened. This concept is currently carried out in Sri Lanka in an adhoc manner without any particular standards or regularisations. It is submitted that this method should not be discouraged but should be encouraged with better regulatory framework. Regulations could be introduced through Tourism Act No. 38 of 2005 or Apartment Ownership Act No. 39 of 2003 by identifying the minimum criteria as to standards for guests, maximum number of guests which can be accommodated, and to ensure that the other tenants are least inconvenienced by this.

6. Amusement Parks

Yet another attraction in the hospitality industry is theme parks or amusement parks. In Sri Lanka apart from Sathutu Uyana and Leisure World there are very few large scale amusement parks. In this the key concern is regarding injury. Injuries to riders get heavy media coverage and having exclusion clauses itself will not be sufficient. This is still a developing area in Sri Lanka and the laws on this may need to be revisited in time to come.

Footnotes

¹In terms of section 2 of the Prevention of Frauds Ordinance No. 7 of 1840 of Sri Lanka as this is an interest on immovable property.
²In terms of s.4 (i) of the Stamp Duty (Special Provisions) Act No 12 of 2006 of Sri Lanka
³[1987] 1 S.L.L.R 05
⁴Supra 8, p.31
⁵[1989] 2 S.L.L.R 272
⁶See Data Protection in a Virtual age section 3.4 of this paper
⁷See Tom Page, Hotels v Online Travel Agents, Whose side are you on? , Hotel Year book 2012, (Published by Ecole hôtelière de Lausanne)
⁸http://en.wikipedia.org/wiki/Timeshare accessed on 18th July 2012.
⁹Florida based 'Vacation Property Services Inc.' was issued a restraining order in carrying out telemarketing of timeshare schemes with misrepresenting the resale value in April 2011. See http://www.dailyfinance.com/2011/04/01/court-shuts-down-timeshare-resale-scam-alleging-fraud/ accessed on 18th July 2012.
¹⁰UK Office of Fair Trading issued a statement in July 2012 exposing three such fraudsters. See. http://www.timesharepages.com/scam-watch/uk%e2%80%99s-oft-takes-3-timeshare-scam-cases-to-high-court/ accessed on 18th July 2012.
¹¹Section 2 of Prevention of Frauds Ordinance No. 07 of 1840
¹²Section 23 (f) of Electronic Transactions Act no. 19 of 2006.
¹³See for details on http://www.hostels.com

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