This article examines a few of the owner-rights typically contained in an O&M Agreement.
It is Part IV in our series of articles on setting up and operating a co-working space in India.
Part I of the series details the issues addressed by a legal due diligence undertaken on a premises to identify risks associated with converting the same into a co-working space.
Part II of the series details the typical issues addressed by a technical due diligence undertaken on a co-working space to ensure continuous, safe, and incremental operations from the same.
Part III of the series details the safeguards and mechanisms that a co-working space operator can negotiate to nullify or mitigate the adverse affects of the sale of such property to a third party.
Part V of the series details the core conditions of the pre and post-take-over phases during the setting up of a co-working space, and the corresponding obligations of the parties.
Managing and operating a co-working space requires a certain level of expertise that most space owners may not possess. These owners must therefore turn to professional co-working operators who will manage and operate their space as a co-working unit. Naturally, owners would want to seek and retain certain rights over their properties to ensure that their objective is being addressed by the operators.
Inspection of premises. Typical operations and management contracts ('O&M Agreements') provide limited rights to the operator in respect of the premises; viz. the right to manage and operate the property on the basis of its operating policies and trademarks. Owners continue to retain possession over the property even when the same is being operated and managed by the operator. In such cases, owners have the right to enter into the property at any time. However, O&M Agreements typically provide that such right should be exercised only by prior information to the operator. The right of an owner to enter into its property may be enforced to conduct inspections or audits of the property, or the operations being conducted therein. Owners should also have the right to conduct the said inspections and audits using their authorised representatives and professional advisors.
Books of accounts - Audits. In addition to inspection and audit of the premises, owners should also have the right to audit the books of accounts of the operator in regards to the operations being undertaken from their premises. Since typical O&M Agreements envisage the transfer of the difference between the gross receipts and gross expenses (i.e. the gross operating profits) in the accounts of the owners, owners typically retain the right to conduct such audits to verify the accounts, and to ensure that the same are being maintained as per the generally accepted accounting principles.
Co-branding. In some arrangements, the co-working space may be co-branded with both the operator's and the owner's trademarks, and at times may only be branded with the owner's trademarks. In such an arrangement, the owners retain the exclusive right to their trademarks. Consequently, the owners have the right to prevent the operators from appropriating the trademarks for its other properties; and depending on the manner in which such trademarks are being held by the owner (i.e. by itself or through its affiliated entities) the owner may also be entitled to receive license payments in respect of such trademarks. Owners will also have the right to approve the relevant marketing materials containing such trademarks - viz. design and content, and mode of advertising, etc.
Retrofitting. In cases where the premises is proposed to be fitted-out, or additional work is required to be conducted to transform the space into a co-working space, the funds for such retrofitting is typically paid for by the owner. In such cases, even though the specifications are provided by the operator, the owner should have the right to discuss the quantum of expenditure with the operator, and where it feels such expenses or modification is unwarranted, the owner should have the right to bring the same to the notice of the operator. However, since such owners are often not well-versed with the design and fit-out requirements that are generally expected of a co-working space, it is advisable that they should opt to have the plans verified by a third-party expert to ensure that the same are adequate for the purpose. Most O&M Agreements provide for an approval mechanism for any fit-outs/ modifications that are required to be undertaken prior to the opening, and the owner therefore should have the right to render their views on the same.
Time commitments. Owners should ensure that the preparation, pre-opening and post-opening activities in respect of the co-working space is being conducted by the operator as per the time schedule provided in the O&M Agreement. In this respect, owners will have the right to seek specific and timely performance of the obligations of the operator. O&M Agreements may also provide that in the event the operator is unable to render its obligations in the manner as envisaged in the agreement, the owners will have the right to seek appropriate damages from the operator. This is to ensure that the owner is in a position to receive appropriate and timely return on the capital expenditure incurred by it on setting up the co-working space.
Performance review. O&M Agreement should provide definite time periods upon which the owner and the operator would meet to discuss and review the performance of the operator in respect to the co-working space. Subject to the contract, operators may be under an obligation to ensure that the revenue realised from the operations is at least at par with other similar co-working operations by third-parties ('Competitive Set') within a fixed geographical radius. Such determinants provide appropriate standards of revenue that are expected to be generated from the co-working space in such territory. Owners may want to negotiate appropriate measures to be implemented in the event it is found that the revenue targets are short of the agreed targets. In such cases, typically if the revenue falls short by more than 20% of the Competitive Set (weighted average basis), the owner may retain the right to terminate the O&M Agreement. The owner may also retain the right to terminate the agreement in case the projected gross profits from the operations falls short of the agreed minimum.
Budgeting. Since in an operations and management arrangement the owners are responsible for providing the working capital for the operations of the co-working space, owners invariably have a significant say in the annual budget prepared by the operator. The annual budget is finalised pursuant to mutual discussion between the operator and the owner. The owner will therefore have the right to approve the annual budget, before the same is implemented.
Conclusion. While higher levels of expertise mean that operators typically have the upper hand when decisions and plans in regards to setting up and operating a co-working space is concerned, owners, because of their significant investment into the space, also have definite rights in regards to the same. When negotiating terms of an O&M Agreement, owners should ensure that they have reserved for themselves appropriate rights that allow them an insight into the operations of the co-working space, and to take remedial or mitigative steps in the event the targets agreed between the parties is not being met.
Originally published 24 January, 2020
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.