Article by
James M. Norman 
Eric Schake - Guest Author
Christian Ryan - Guest Author
James M. "Jim" Norman is a partner in our Fort Lauderdale office.
"True is it that we have seen better days."1
Owners and operators certainly do not need another thing to argue about, especially in the current economic environment. While new management deals are scarce, renegotiated contracts – whether with the original owner, the lender, or a new owner – are becoming more commonplace every day. Of course, the base management fee and incentive fee terms are discussed at length. In addition to all of the other issues that we've become accustomed to seeing in term sheets, rights relating to shutdowns (temporary, total or partial), ranging from weeks and seasons to indefinite or long-term closures are being done or considered. Management agreements of the future are likely to contemplate these types of events.
"Tempt not a desperate man."2
When times get tough, disputes throughout society become more common. Unfortunately, the hospitality industry is not immune to this side effect of economic duress. Much could be said and written about the underlying causes and motives, but for purposes of this article, let's chalk it up to "human nature" and let it go at that.
"Fair is foul, and foul is fair."3
When owners become more litigious, operators and their counsel look for ways to insulate and inoculate against successful claims. Provisions relating to negligence, indemnification and dispute resolution attempt to deal with this area of exposure. Another vehicle is to have a special purpose entity created by the operator to have, as its sole asset, the management agreement for a particular property. This should not, in and of itself, be viewed as a new or recent development. Many brand management companies have subsidiaries that operate hotels or resorts of a certain type or in a particular geography. There is nothing inherently objectionable in this strategy – it makes good common sense and good business sense.
"Having nothing, nothing can he lose."4
Owners, on the other hand, are legitimately concerned about having an entity with sufficient assets "on the hook" in case of a major claim that is not excluded by the terms of the hotel management agreement. Their response is to demand an ultimate parent guarantee or a guarantee from the top tier management subsidiary. This is often a tough pill for the operator to swallow.
If a guarantee is not forthcoming, what could take its place? A letter of credit? Too expensive and requires frequent renewal. And, neither side wants to absorb these costs. Having the management entity be required to always maintain not less than a specified number of management agreements at all times, failing which the owner has a termination right, is far less than ideal.
"You pay a great deal too dear for what's freely given."5
Minimum insurance requirements are specified in detail by the operator in management agreements, generally through an exhibit listing coverages, limits and certificate standards. What is rarely seen, however, is any discussion of operator errors and omission insurance. Could this coverage reduce or eliminate some areas of liability risk allocation that drives owners to seek guarantees or complain about standard negligence provisions of management agreements?
Let's examine what hotel operator errors and omissions (E&O) coverage does and does not do.
Hotel operator E&O policies provide assurance to the owner that the owner has recourses against the policy and not just the assets of the special purpose entity established for this property. These policies generally provide that the insurer will:
- pay on behalf of the insured all sums that the insurance company shall become legally obligated to pay by reason of any act, error, or omission rising out of services an insured negligently rendered or failed to render, subject to the limitations and exclusions of the policy
- pay for the defense of any claim or suit that is covered by this insurance
"This is the long and short of it."6
When an owner is in the process of selecting a hotel management company, it is important to have the owner's insurance and risk management consultant review all E&O policies the management company has in force. Most E&O policies cover all current and past assets that the operator has managed but there is a risk that the policy limits may have been exhausted or reduced by prior claims. The owner may request a separate and dedicated policy for the specific property, which is also known as a "Project/Asset Specific E&O" policy. With this type of policy, the owner is assured that the policy limits are dedicated to its property and not shared over other managed properties. Project/asset specific programs are typically a bit more expensive and premiums are based on contract/agreement scope and size, revenues and the operator's claims experience.
Hotel operators E&O policies limits generally range from $2.5 million to $10 million limits with retentions/deductibles ranging from $10,000 to $500,000 per claim. Deductibles and retentions vary depending on each management company's ability to retain or self-insure risks.
Underwriters offering these policies currently include:
- AIG/Chartis
- ACE
- Zurich
- XL
- Hartford
- London (Beazley)
- Chubb
"Wisely and slow; they stumble that run fast."7
Hotel operator E&O coverage is not a silver bullet that eliminates all concerns about special purpose entities or limited asset entities being the operator of a hotel or resort. However, it can be a partial solution. As with most insurance, knowledgeable consultants are an essential part of the negotiating team. Issues ranging from "Does it matter whether the owner or operator employs the employees?" to "What if the operator files bankruptcy?" will undoubtedly ripple through the negotiation of the management agreement and the possible use of insurance to find a negotiated middle ground.
This relatively inexpensive insurance may be part of the solution to the operator parent guaranty demand an owner makes, but only if the provisions of the management agreement and certain legal issues are covered through management agreement language or insurance policy endorsements.
Jim Norman would like to thank guest authors Eric Schake, Executive Vice President, and Christian Ryan, Senior Vice President, both at Willis North America in Dallas, Texas.
The authors wish to posthumously thank William Shakespeare for his foresight in understanding and characterizing hotel operator E&O coverage.
Footnotes
1. As You Like It (Act II, Scene VII)
2. Romeo and Juliet (Act V, Scene III)
3. Macbeth (Act I, Scene I)
4. King Henry VI, Part III (Act III, Scene III)
5. The Winter's Tale (Act I, Scene I)
6. The Merry Wives of Windsor (Act II, Scene II)
7. Romeo and Juliet (Act II, Scene III)
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.