hotel management agreements: key topics and new...

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Presenting a live 90-minute webinar with interactive Q&A

Hotel Management Agreements:

Key Topics and New Frontiers Navigating Fees, Exclusivity, Approval Rights, Finance Provisions, Brand Management and More

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, JUNE 7, 2017

Albert J. Pucciarelli, Partner, McElroy Deutsch Mulvaney & Carpenter, Ridgewood, N.J.

Ormend G. Yeilding, Shareholder, Lowndes Drosdick Doster Kantor & Reed, Orlando, Fla.

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I. BRAND MANAGEMENT AGREEMENTS AND NEW HOTEL

DEVELOPMENTS

Ormend G. Yeilding, Esq., Shareholder Hospitality & Leisure Practice Group

[email protected]

Issue:

• In hotel development deals, lenders will not fund a construction loan until the brand management agreement is in place. But how does a management agreement work with respect to a hotel that does not yet exist?

• This issue is resolved in a separate document – either as a stand-alone agreement or as an addendum to the management agreement – that governs the obligations of Manager and Owner between the closing of construction financing and opening of the hotel. This document is usually called a “Technical Services and Pre-Opening Agreement [or Addendum].”

6

Brand Management Agreements and New

Hotel Developments

The Technical Services and Pre-Opening Agreement [or Addendum] or “TSA”

As the title implies, the agreement is comprised of two main sections:

1. Technical Services: this section governs the construction phase and details the types of plans and specifications for the new hotel that must be submitted by Owner to Manager for approval, and sets forth the deadlines for construction milestones between Owner and Manager.

2. Pre-Opening – this part of the TSA governs the 6 to 12 months prior to hotel opening, setting forth the actions that Manager will take (at Owner’s expense) to get the Hotel operationally ready for opening, such as hiring staff, pre-selling rooms, etc.

7


Hotel Developments

Technical Services in More Detail

What the Manager Wants in the TSA:

• Owner’s obligation to provide submittals to Manager for review for compliance with brand standards at every stage of the hotel design through final construction plans.

• Manager to have approval rights over the major project consultants, such as the architect, engineer, general contractor and interior designer.

• Owner’s obligation to build the hotel in accordance with the Manager-approved plans on a timely schedule, with deadlines for commencement of construction, substantial completion and opening.

• Fee from Owner to compensate Manager for its review of plans.

8


Hotel Developments

Technical Services in More Detail

What the Owner Wants in the TSA:

• Specific limit on time to review – such as 15 to 45 days depending upon type of submittal.

• Specific Standard of Review – since construction can take from 18 to 36 months, want to “lock down” the specific applicable brand standards in place at the time of the TSA, so that Owner doesn’t have to revise plans to accommodate changing standards.

• “One Bite at the Apple”: once Manager has approved plans, the plans are then “deemed” to be in compliance with brand standards (even if they technically are not in compliance). Owner needs to be able to rely on Manager’s approval.

9


Hotel Developments

Pre-Opening in More Detail

What Manager Wants:

• Needs notice from Owner as to date that is one year prior to projected opening, so that Manager can begin hiring employees for and marketing the hotel.

• Owner funding of all pre-opening expenses, and payment of a pre-opening fee for these services to Manager (otherwise Manager does not begin earning regular management fees until hotel is open and generating revenues).

• Manager to have final say when the hotel is authorized to open under the Manager’s brand.

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Hotel Developments

Pre-Opening in More Detail

What Owner Wants:

• All pre-opening expenses to be subject to a budget agreed to by Owner and Manager, and reasonable approval rights over material variances from the budget.

• Manager to be subject to a “reasonableness” standard for authorizing hotel opening (punch-list items can be completed after opening).

• Clearly defined dispute resolution process – since normal litigation claims are not practical in a construction process, consider establishing a committee of “decision makers” from each of Owner and Manager who are empowered in the TSA to hear disputes about approval of plans, authorizations, etc., on a timely basis.

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Hotel Developments

Hotel Management Agreements: Top Ten Topics

for 2016 and Beyond – CLE Webinar – April 14, 2016

II. FEES:

BALANCING INCENTIVES

Albert J. Pucciarelli, Esq., Partner

Chairman, Hotel and Resorts Practice Group

[email protected]

Albert J. Pucciarelli, Esq., Partner Chairman, Hotel and Resorts Practice Group

REVENUE BASED- - Base Fee – Typical: 3% of Gross Revenue

- Marketing Fee – Typical – 1% of Gross Revenue

- Negotiable? Maybe a ramp up in early years of a

new hotel

- For an existing hotel, Owner may seek a fee that is

a higher percentage, but only a percentage of

Gross Revenue in excess of previously achieved

levels; this will be resisted by the big brands

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INCENTIVE FEE – Rewards not just volume (Gross Revenue) but operating efficiency. Typical: 10% of Gross Operating Profit – i.e., Gross Revenue MINUS Operating Expenses – i.e., just those expenses that are within the control of the Manager and therefore include routine departmental expenses, but do not include the traditional “below-the-line” items: - FF&E Reserve (negotiable) - Capital Expenditures - Property Insurance - Property Taxes - Debt Service - Depreciation - Distributions/Dividends - Owner’s Income Taxes

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Alternatively, the incentive fee may be a percentage of Income Before Fixed Charges* or Income Before Fixed Charges MINUS the FF&E Reserve or Net Operating Income† or even Net Income.‡

_____________________________________________________

*Income Before Fixed Charges = Gross Operating Profit MINUS Base Fee.

† Net Operating Income = Gross Operating Profit MINUS Base Fee, Insurance Premiums, Property Taxes and Ground Rent.

‡ Net Income = Net Operating Income MINUS Replacement Reserves, Income Taxes and Depreciation.

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SOME VARIATIONS ON INCENTIVE FEE FORMULAE: • Earned as a percentage of Gross Operating profit but only paid to the

extent of Net Operating Income in excess of Owner’s Priority which is typically a percentage of project cost increased by subsequent capital expenditures; Earned but not paid fees accumulate and may or may not bear interest and are paid to the extent of excess NOI after current Incentive Fees are paid.

• Or a higher percentage – say 25% - of Net Operating Income (all expenses before the replacement reserves, debt service, depreciation and income taxes).

• Or for an existing hotel, a higher percentage, but only of Gross Operating Profit in excess of a previously achieved level.

• There are many variations that are the ‘stuff’ of hard negotiation.

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OTHER CHARGES/FEES:

Central Service Charges – e.g., reservation charges (typically $X per

reservation), reward programs (typically a percentage of Room Revenue

generated by the reward-program member who is a guest at the hotel),

employee training charges, brand marketing charges and more - be sure to

limit these to the extent possible to cost recovery and make them apply in the

same manner as they apply to all other hotels in the chain.

Voluntary (Optional) Programs – such as optional purchasing programs,

technical services for improvements, quality audits and more.

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CREDIT ENHANCEMENTS: Assistance from the Manager to Fund the Project to Build or Acquire the Hotel

Some examples –

• Equity Participation

• Subordinated/Mezzanine Loan

• Key Money

• Fee Subordination (e.g., Incentive Fee with an Owner’s Priority)

• Debt Service Guaranty

• Contribution of Technical (and Other) Services

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III. KEY MONEY The Brand’s Gift to Owner of Golden

Handcuffs (kidding!*)


[email protected]

*sort of

What is Key Money?

• Key Money is special financing provided by the Manager to Owner in exchange for a long term management contract, usually for a newly-built hotel or for an existing hotel being renovated and reflagged under the Manager’s system.

• Key Money is popular with Owner’s because, theoretically, Key Money does not have to be repaid . . . but there are strings attached…

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Key Money

General Terms:

• The amount of Key Money available depends upon the size of the hotel and length of the management agreement. This could range from $500,000 to $15,000,000.

• Key Money is paid after the hotel opens (it is not paid at the time of construction financing)

• Structured as an unsecured loan bearing 0% interest that is partially forgiven each year during the initial term of the management agreement. For example, if Manager provides $1,000,000 in Key Money for a management agreement with a 20 year initial term, 1/20th of that amount ($50,000) is forgiven each year that the management agreement remains in place.

• If the management agreement terminates for any reason during the initial term, the then-unforgiven balance of the Key Money is immediately due and payable to Manager.

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Key Money

What’s the Catch?

• When a Manager agrees to provide Key Money, the Manager usually becomes less flexible in negotiating other provisions of the management agreement (such as with respect to term, fees, performance termination, etc.)

• An outstanding Key Money obligation can complicate a later sale of

the Hotel. Brand management agreements must be assigned at Closing to the buyer. The seller, who received the key money, wants buyer to assume the contingent repayment obligation at closing since seller will have no control over whether the management agreement terminates after the sale. The buyer does not want to assume the repayment obligation because the buyer never received the benefit of the Key Money. This is usually resolved with Buyer assuming the obligation at closing, but receiving a comprehensive estoppel from Manager stating the unforgiven balance of Key Money, and that there exist no defaults under the Management Agreement.

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Key Money

What’s the Catch? (cont’d)

• Key Money can also complicate financing. Sometimes lenders may require Key Money to be escrowed and spent only on specific improvements to the hotel collateral. Lenders may also require a complete release from Manager from any liability to pay the unforgiven Key Money obligation to Manager in the event the management agreement terminates following a foreclosure. Manager may not be willing to provide this release.

• In these respects, Key Money can be described as both the “cheapest” and “most expensive” financing an Owner can get.

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Key Money

IV. THE PERFOMANCE TEST:

MAKE IT MEANINGFUL!



[email protected]


WHAT IS A TYPICAL TEST?

- Currently Brand management companies must fail two tests

before facing termination, a profit threshold test and a REVPAR

test. The REVPAR test is a comparison of the hotel’s revenue

performance against a “competitive set” of similar hotels in the

market. Under the traditional test, to face termination, the

Management Company must not only fail to perform, but perform

poorly in relation to other hotels. Many have criticized the

traditional test as having resulted in very few terminations during

the recent severe recession. Brands would argue that the

traditional test performed exactly as designed, since performance

declined due to macroeconomic factors outside of the

management companies’ control.

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A TYPICAL PERFORMANCE TEST - CONTINUED

• If in any consecutive two-year period (a) budgeted GR [or GOP] is less than 90% of budgeted GR [or GOP] AND (b) the hotel does not achieve at least 90% of the RevPAR of the Competitive Set, and such failure is not the result of Force Majeure….

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WHAT IS A MEANINGFUL TEST?

A test that is measured as a function of Net Income – the Owner’s

bottom line. At the end of the day, the hotel is in a sense a joint venture

between owner and manager, and test that is passed even while the

owner has a net operating loss or is not achieving its planned income

level may mean that the owner has the wrong brand or manager, or has

built or acquired the wrong hotel for the market. In any case, a

manager remaining in place and taking fees while the owner is losing

money seems a bad venture, ultimately that will inure to the detriment

of both parties.

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OWNER’S RESPONSE

• Replace two consecutive years with any two of three consecutive years...

• Increase the percentages, making the RevPAR test greater than 100%...

• Change “and” to “or”.

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ANOTHER ALTERNATIVE TEST

One innovation may be to institute a “Performance Relief”

concept, whereby management fees and certain other

management related expenses are automatically reduced

during a sustained period of REVPAR declines below a

certain threshold, so that Owners’ and brand management

companies’ interests are aligned even during a recession.

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TIMING OF THE TEST: COMMENCEMENT

MANGER’S POSITION – a “black-out period” – i.e, the test

commences only after the hotel has achieved “stabilization”

under the new manager. In the case of a new hotel, the test may

not take effect until years three, four or five from opening. In

the case of an existing hotel, the black-out period should be

shorter – perhaps one year.

OWNER’S POSITION – no “black-out period” or at least one that

is as brief as possible so that the test commences as soon as the

new manager is in control.

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TIMING OF THE TEST: THE YEARS TO MEASURE

MANGER’S POSITION – the test must be failed for two

consecutive years.

OWNER’S POSITION – the test has been failed if a failure

occurs in any two of three consecutive years.

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CURE: WHAT TO CURE AND EFFECT OF THE CURE

MANGER’S POSITION – the cure payment is the least amount

necessary to render a passing grade – so, for example, if the

budgeted in test year 1 was $50,000 short, the cure payment is

$50,000 and that negates the result for the two years in

question.

OWNER’S POSITION – the cure payment cures only the year in

question. In the example above, year 2 would remain as a failed

year, possibly to be counted as year one of the next two-year

period that remains countable as a failed year.

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LIMITATION ON CURE RIGHTS

MANAGER’S POSITION: unlimited cure opportunities.

OWNER’S POSITION: only two in the term; also, if Manager has a unilateral renewal right (insisted upon by some management companies), any failure of the performance test during the initial term negates that right.

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THE COMPETITIVE SET

• Should be truly representative of the competition in the market

• Should be updated periodically by agreement of the parties to include new market entrants; if they cannot agree, this is a good place to use “expert determination”.

• It is reasonable to expect your hotel to beat the competitive set if you have chosen the right brand.

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V. LENDER HOT BUTTONS REGARDING BRAND

MANAGEMENT AGREEMENTS


[email protected]

Main Issue:

• The Lender considers the hotel brand and its operation as key components in underwriting the loan to Owner. But the owner of the Brand and the operator of the hotel are not borrowers under the loan.

• This issue is resolved by a combination of Owner covenants in the loan agreement regarding the Manager and the management agreement, and by an SNDA, which is a three party agreement between Owner, Lender and Manager governing the rights of each.

• Key point: Owners need to make sure the management agreement comports with the requirements of the loan agreements, and vice versa.

36

Lender Hot Buttons Regarding Brand Management Agreements

Loan Agreement provisions regarding or relevant to the Manager and Management Agreement:

• Owner collaterally assigns its right, title and interest in and to the Management Agreement (this may require Manager consent, provided in the SNDA).

• Owner will not make any material amendments to the Management Agreement (such as to fees, term, etc.) without Lender’s prior consent.

• Owner will not terminate the Management Agreement without Lender’s prior written consent.

• Owner will not enter into any space lease or material supply contract over a certain threshold without Lender’s prior written consent – but note that the Management Agreement authorizes Manager to enter into leases/contracts in Owner’s name up to a certain threshold – Owner needs to make sure these don’t conflict.

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Loan Agreement provisions regarding or relevant to the Manager and Management Agreement (cont’d):

• Owner to provide monthly, quarterly and annual financial reports regarding the performance of the Hotel. But note that Owner relies on Manager to provide financial reports in the management agreement – Owner needs to confirm that the types of financial reports to be provided by Manager, and when Manager will provide such reports, in the management agreement will enable Owner to comply with the loan agreement.

• Both the loan agreement and the management agreement will require a reserve for FF&E and routine capital expenditures. Owner needs to make sure that the reserve under the management agreement will suffice for the loan agreement, and that the reserve provisions of the management agreement are compatible with Owner’s obligations under the loan agreement

38


Subordination, Non-Disturbance and Attornment Agreements (SNDAs):

• Signed by Owner, Lender and Manager

• Subordination – Manager agrees to subordinate its interest in the hotel to Lender’s mortgage.

• Non-Disturbance – Lender agrees to continue to honor the management agreement following a foreclosure.

• Attornment – Manager agrees to consider the Lender the “Owner” under the management agreement following foreclosure.

39


Common SNDA Issues:

• The modern SNDA took shape in the context of commercial leases for loans involving office buildings, shopping centers, and the like. As the hotel industry has transitioned over the past few decades with brands being “asset light” and preferring long term management agreements to owning their own hotels, commercial lending looked to the commercial lease SNDA as a model for the new hotel management agreement structure.

• This makes sense, in that modern brand management

agreements resemble leases in that they are long-term contracts granting the manager a possessory interest in the hotel and right to operate the business.

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Common SNDA Issues: (cont’d)

• BUT – management agreements differ from leases in many important ways that implicates the SNDA. First, Manager is not responsible for operating losses of the business. Second, revenues of the hotel under the management agreement are gross revenues needed to pay operating expenses on a daily expenses, whereas rent provides the revenue under a commercial lease. Third, the brand management agreement provides affirmative obligations on the Owner beyond what a lease requires of a landlord. These differences have many implications for the Manager SNDA.

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Key SNDA Issues for Resolution:

- Cash Management: Lockbox of all revenues, or just NOI paid to Owner?

- Lender will require right to see financial statements, and covenant from Manager not to amend without consent. Owner needs to confirm Lender is not demanding more rights in SNDA than Lender has in loan agreements.

- Subordination of fees: Base Fee vs Incentive Fee

- Lender cure rights of Owner defaults

- What does “Non-Disturbance” mean? After foreclosure, does Lender have to pay amounts owed by Owner to Manager?

- “Non-Disturbance” – does this extend to Lender having to sign a new management agreement if original terminated in bankruptcy?

- Lender needs confirmation that lender is an approved “assignee” in a foreclosure situation, and that foreclosure will not trigger any ROFR or ROFO.

42


Hotel Management Agreements: Top Ten Topics

for 2016 and Beyond – CLE Webinar – April 14, 2016

VI. OWNER APPROVAL RIGHTS:

YOU SIMPLY CANNOT TURN OVER

THE KEYS AND WALK AWAY.



[email protected]


OWNER APPROVAL RIGHTS GENERALLY

• The nature of an owner’s approval rights in the case of a managed hotel will vary depending upon the owner’s own real estate management expertise and whether or not the owner has an “asset manager” – either an individual, an internal department or an asset management company.

• The major brands will insist on a high degree of control over the operational aspects of the hotel – from rates, to menus to life safety standards – an in a sense, it is this expertise that the owner is paying for.

• Even so, an owner should be involved in certain key aspects of the hotel’s operation, and most certainly will have to be responsible for those P&L items that fall below the GOP line – such as property taxes, property insurance, ground lease obligations, if any, property taxes, debt service and capex.

44


THE ANNUAL PLAN This is an owner’s most significant on-going, operational involvement

• Review and approve the annual plan

• More than just the budget for the next FY – also a personnel plan, a

marketing plan, a plan for the use of the FF&E reserve, a capex plan…

• Items in dispute may be submitted to an “expert” or applied from last

year’s budget, adjusted by a CPI number

• Carve-outs from owner’s approval right may include utilities, central

service charges by the brand and costs to comply with brand standards

(CAVEAT), life safety and legal requirements

• Owner should require periodic forecasts vs. budget and a revised budget

in mid-year, subject to owner’s approval, where the original budget and

forecast have parted company.

45


THE EXECUTIVE COMMITTEE

In the US, all hotel employees are likely to be employees of the management company

and outside the US, they will be employees of the owner, although certain key

personnel will be “secunded” by (on assignment from) the management company

In either case, the owner should have the right to approve the selection by the

management company of “key personnel” – and have their resumes and other data,

such as background searches, available to the owner and an opportunity to interview

these persons

“key personnel” = General Manager, Director of Marketing and Sales, Controller

An owner is not likely to have the power to fire ANY employees, but should at least

have a complaint opportunity with a written response as to corrective action.

46


CERTAIN AGREEMENTS

• Commercial space agreements, such as shop leases, parking lot management agreements and roof-top antennas, or at least those that have a term in excess of one year or cannot be terminated without penalty on 30 days notice.

• Collective bargaining and employment agreements.

• No management involvement in CCRs, easements or secured loans.

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LITIGATION

• Commencement and settling of non-routine claims, proceedings and lawsuits

• Choice of counsel for all or at least non-routine lawsuits

• Property tax appeals and settlements

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A WORD ABOUT THOSE CONFUSING AGENCY CASES!

• The previously “settled” common law rules.

• The Maryland Statute anti-dote.

• And now recent New York cases have “unsettled” the whole thing.

• What is needed? A line of cases that leaves the parties to their deal as embodied in their carefully drafted, well-negotiated HMA.

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Thank You

50


[email protected]

Ormend G. Yeilding, Esq., Partner

Hospitality & Leisure Practice Group

[email protected]

hotel management agreements: key topics and new...

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