The HMA & Franchise Agreement Handbook

BoB Braun

Partner and Senior Member,

JMBM Global Hospitality Group®

Jim Butler

Chairman,

JMBM Global Hospitality Group®

The HMA & FRANCHISE AGREEMENT HANDBOOKThe HMA & FRANCHISE AGREEMENT HANDBOOK

Jim Butler is the author of the Hotel Law Blog and Chairman of

the Global Hospitality Group® at Jeer Mangels Butler & Mitchell

LLP (JMBM). For more than 35 years, Jim and his team have helped

hotel owners, developers, investors and their lenders nd business

and legal solutions with their unequaled hotel experience gained

over more than $123 billion of hotel transactions, involving more

than 4,600 properties all over the world.

About the Authors

he HMA & Franchise Agreement Handbook is a valuable resource for hotel

owners, developers, investors and lenders. It is written in plain

language for business people who don’t have full-time jobs negotiating

hotel management agreements every day, but want the kind of legal and business

advantages and insights they would get if they did.

Drawing on practical experience gained over more than 30 years, more than 2,700

hotel management contracts and hundreds of hotel franchise agreements, Jim

Butler, Bob Braun, and Mark Adams are hotel lawyers and veteran advisors who

can help you quickly sort out what is important and what is not.

The The

HMA & FRANCHISE AGREEMENT HMA & FRANCHISE AGREEMENT

HANDBOOKHANDBOOK

Hotel Management Agreements

& Franchise Agreements

for

Owners, Developers

Investors & Lenders

5th

edition

TheThe

HMAHMA

FRANCHISEFRANCHISE

AGREEMENTAGREEMENT

HANDBOOKHANDBOOK

Bob Braun is a transactional lawyer who has negotiated hundreds

of hotel management, franchise and license agreements for

owners, developers, investors and lenders. A senior member of

the Global Hospitality Group® at Jeer Mangels Butler & Mitchell

LLP, Bob represents hospitality clients in both transactional and

operational issues.

Mark Adams focuses his practice on business litigation, including

contracts, products liability, corporate and partnership disputes,

and hospitality litigation. Mark has successfully litigated many

high prole cases on hotel management agreements and

franchise agreements, duciary duty issues, investor-owner

disputes, TOT assessments, and other hotel-specic issues.

mark adams

Partner and Senior Member,

JMBM Global Hospitality Group®

Hotel Management Agreements

Franchise Agreements

for

Owners, Developers,

Investors, Lenders & Operators

Jim Butler

Chairman,

JMBM Global Hospitality Group®

____________________________________________________________________

Bob Braun

Partner and Senior Member,

JMBM Global Hospitality Group®

____________________________________________________________________

Mark Adams

Partner and Senior Member,

JMBM Global Hospitality Group®

Published by the Global Hospitality Group® of JMBM

Los Angeles, California

January 2023

edition

Group®.

1st edition, 2011

2nd edition, 2012

3rd edition, 2014

4th edition, 2019

5th edition 2023

We wrote the book™ series:

 The HMA & Franchise Agreement Handbook

 How to Buy a Hotel Handbook

 The Developers EB-5 Handbook

 The Lenders Handbook for Troubled Hotels

 The ADA Compliance and Defense Guide

Dedicated to levelling the playing field for

hotel owners, developers,

investors, lenders and operators.

Highlights in the new edition of the

HMA & Franchise Agreement

Handbook

The 5th edition of the HMA & Franchise Agreement

Handbook has been updated and expanded to stay

current with the latest important developments in the

hotel industry, including the following:

 Maryland law changes historic rights and remedies

in HMA and franchise litigation

 How to get a great hotel operator and a fair HMA

 The five biggest mistakes hotel owners make

 When should you choose a brand an independent

operator for your hotel?

 Eight things to negotiate in your next franchise

agreement

 Comfort letters in financing franchised hotels

 The two sides of dual-branded hotels

 Why most long-term hotel management agreements

may now be terminable

Table of Contents 
The HMA & Franchise Agreement Handbook
  iv 
Overview by Chekitan S. Dev ......................................................... vi 
Foreword by Jan A. deRoos .......................................................... vii 
Preface by Jim Butler ........................................................................ ix 
Introduction ....................................................................................... x 
Getting started — terminology ....................................................... xi 
About the authors ........................................................................... xiv 
CHAPTER 1 — HOW TO GET A GREAT HOTEL 
OPERATOR 
Maximizing hotel value with management, branding 
and franchise .............................................................................. 2 
Three of the most important things you will ever do 
for your hotel .............................................................................. 4 
The five biggest mistakes hotel owners make in 
selecting operators and negotiating brand HMAs ................ 9 
How to get a great hotel operator and a fair hotel 
management agreement .......................................................... 13 
HMA PRO™ Checklist ............................................................ 18 
How to make your HMA PRO™ successful — a 
practical guide .......................................................................... 22 
How to negotiate an HMA ..................................................... 25 
CHAPTER 2 — WHAT YOU NEED IN YOUR HOTEL 
MANAGEMENT AGREEMENT 
What to do before you start negotiating your brand 
HMA .......................................................................................... 30 
Hotel management agreement performance 
standards and why they matter ............................................. 35 
Hotel management agreement performance 
standards — the operator's take ............................................ 39 
Hotel management agreement performance 
standards —  the Owner's Return test .................................. 44 

Table of Contents 
The HMA & Franchise Agreement Handbook
  v 
Five keys for good HMA budget provisions ........................ 48 
Indemnification provisions ..................................................... 54 
SNDAs: Subordination agreements affect the value, 
financeability and collateral value of a hotel........................ 58 
Exculpation clauses — protecting the owner's assets ......... 64 
CHAPTER 3 — ABOUT FRANCHISE AGREEMENTS, 
BRANDS & INDEPENDENT OPERATORS 
Decisions about brands and management............................ 68 
The myth that franchise agreements cannot be 
negotiated ................................................................................. 75 
The importance of comfort letters in financing 
franchised hotels ...................................................................... 80 
Brand franchise issues in hotel purchase and sale 
transactions ............................................................................... 83 
Dual-branded hotels — what every owner or 
developer should know .......................................................... 89 
Five things to keep in mind when you look for a hotel 
operator ..................................................................................... 92 
CHAPTER 4 — HOW TO TERMINATE A HOTEL 
MANAGEMENT AGREEMENT 
What can you do when an HMA isn't working? ................. 96 
What happens in hotel management agreement 
lawsuits? .................................................................................... 99 
Maryland law changes historic prevailing rights and 
remedies in HMA and franchise litigation ......................... 104 
Epilogue .......................................................................................... 114 
About HotelLawer.com and The Hotel Law Blog .................... 115 

The HMA & Franchise Agreement Handbook

Overview by Chekitan S. Dev

Jim Butler, Bob Braun and Mark

Adams have delivered another

edition of their hotel

management and franchise

agreement 'Bible' for owners,

lenders, brands, and operators.

The new edition of their

handbook totally satisfies my

3Cs: it is complete, current, and

comprehensive. The book has

everything you need to know

about the subject, it is up to date with all the current topics relating

to HMAs and franchise agreements, and it covers each topic very

thoroughly.

The book is well organized, contains many insights and

guidelines informed by their many years of exemplary practice, is

full of tips to follow and traps to avoid, and has several thoughtful

and useful checklists.

The HMA and Franchise Agreement handbook is a 'must read' for

anyone interested in or involved with the creation, negotiation,

administration, litigation or study of hotel management and or

franchise agreements.

Dr. Chekitan S. Dev

Ithaca, New York

January 2023

Dr. Chekitan S. Dev, the Singapore Tourism Distinguished Professor at

Cornell University's Nolan School of Hotel Administration, has testified

as an expert witness at trials and arbitrations in numerous hospitality-

related matters. An award-winning teacher and author, Dr. Dev wrote

Hospitality Branding (Cornell University Press), as well as over one

hundred articles in leading academic and practitioner journals,

including the Cornell Hospitality Quarterly and the Harvard Business

Review.

The HMA & Franchise Agreement Handbook

vii

Foreword by Jan A. deRoos

Why a Practical Guide is Relevant and

Needed by the Industry

Over the past 70 years, hotel owners

and hotel brands (and independent

operators) have developed impor-

tant relationships based on the

considerable value they provide to

each other: one provides the real

property and the other the

intellectual property that together

make a successful hotel.

Not surprisingly, a sophisticated

and legally intricate system of

management agreements (HMAs)

and franchise agreements has evolved to govern how hotel

owners contract with the branded or independent managers who

operate, brand and have long-term control of the hotel's assets.

Fortunately, The HMA & Franchise Agreement Handbook by Jim

Butler, Bob Braun and Mark Adams provides an excellent and

invaluable guide to understanding the important and complex

arrangements created by HMAs and franchise agreements. Now

in its fifth edition, the work is revised and updated with an

understanding that the great questions never change, but the

answers do.

The detailed discussion of HMAs and franchise agreements by

Butler, Braun and Adams is refreshingly direct and candid. It is

written for businesspeople in easy-to-understand language. And

it provides owners, developers, investors and lenders with

pragmatic counsel that only comes from intense hands-on

experience with hospitality matters that comes from representing

many clients over a long period of time.

Today, the names of many hotel owners and hotel operators are

recognizable throughout the real estate capital markets. But it is

not necessarily the case that the party with the greatest market

The HMA & Franchise Agreement Handbook

viii

capitalization or success in other categories of real estate has the

greatest power in negotiating an HMA or franchise agreement.

The Fifth Edition by Butler, Braun and Adams provides essential

information that will help owners, developers, investors and

lenders understand the far-reaching impacts of their HMAs and

franchise agreements, and the important points that can and

should be negotiated.

This version of The Handbook has been revised extensively to

reflect a recent sea change in the hotel industry — the proliferation

of franchise agreements, which have become increasingly

negotiable. Hotel management agreements continue to be critical

for luxury properties, resorts and larger properties. But for bread-

and-butter hotels and the hot select service segment, owners and

brands are placing more importance than ever on franchise

agreements. This shift also raises issues of when to use

independent operators and the more favorable terms that may be

negotiated with them.

The authors' objective of providing the keys for "breaking the

code" to HMAs and franchise agreements is fully realized in this

important work. In addition, by freely distributing this work, they

have committed to educating a broad audience with relevant and

current practice. I commend Butler, Braun and Adams for their

excellent and invaluable book.

Jan A. de Roos, PhD

Ithaca, New York

January 2023

Jan de Roos is the HVS Professor of Hotel Finance and Real Estate

Emeritus at Cornell University's Nolan School of Hotel Administration.

He is co-author of The Negotiation and Administration of Hotel

Management Contracts, long considered to be the industry's seminal

academic reference on hotel management agreements. The current fourth

edition (2009), co-authored with James Eyster, is available via Amazon.

The HMA & Franchise Agreement Handbook is available

electronically through hotel.law/HMA-Handbook.

The HMA & Franchise Agreement Handbook

Preface by Jim Butler

The HMA & Franchise Agreement Handbook

traces its roots to the Hotel Law Blog

The HMA & Franchise Agreement Handbook is drawn from articles

which have appeared on www.HotelLawBlog.com, with edits

and revisions to bring them up to date.

Since the first edition of the handbook, hotel management

agreements, or HMAs, have continued to be critical to the value

of hotel assets; however, hotel franchise agreements have become

more important than ever, and savvy investors are paying greater

attention to getting better operators and better HMAs.

As we revised and updated our original edition, we included

chapters on franchise agreements, brands and independent

management agreements, and sections on how long-term, "no-

cut," branded management agreements might be terminable.

Brands have increased their reliance on the franchising model and

limited the branded management agreement model to key

strategic assets or flags. As a result, the relationships between

brands, independent managers, lenders and owners have become

more complicated. In this 5

edition, we have completed a

comprehensive update and expansion to deal with constantly

changing circumstances and strategies.

All the hotel lawyers of JMBM's Global Hospitality Group® join

me in hoping that The HMA & Franchise Agreement Handbook will

be useful to you and your colleagues. Please contact us with any

experiences or thoughts you would like to share. We always love

to talk with our industry friends on "what it all means" and to see

if there is any way that our resources and experience might help

you accomplish your goals.

Jim Butler

Author of www.HotelLawBlog.com

Founding partner of Jeffer Mangels Butler & Mitchell LLP

Chairman of JMBM's Global Hospitality Group®

Founder and Conference Chairman, Meet the Money®

The HMA & Franchise Agreement Handbook

Introduction

Why your hotel project needs hotel experience ...

because hotels are different!

Hotels are different. And so is dealing with them — whether in

negotiating, litigating, or arbitrating hotel management

agreements; buying, selling, developing, financing or refinancing

transactions; or in workouts, bankruptcies or receiverships.

Hotels require different experience, strategies and documenta-

tion.

The lawyers of JMBM's Global Hospitality Group® are regularly

surprised to see how badly world-class lenders or investors

stumble with hotel assets. These players are often guided by some

of the "best law firms in the country" — top Wall Street law firms

with international reputations. These legal giants may be ideal for

a complex real estate project or corporate finance project because

they have more experience in these areas than other firms. But

hotels are NOT real estate or corporate finance, and however good

these firms may be in other areas of law, their lack of hotel-specific

experience fails them — and their clients — when it comes to hotel

transactions.

We continue to see value that is irretrievably lost, due to this lack

of hotel industry experience at the outset in formulating the

strategies and goals. Unfortunately, strategies and campaigns

launched on the battlefield — whether in workouts, litigation,

acquisitions, or financing — are too often irreversible. Once you

have tripped past a decision point, you cannot go back!

The HMA & Franchise Agreement Handbook is intended to be a

helpful resource for the friends and clients of JMBM's Global

Hospitality Group®. But please listen carefully to this suggestion:

If you don't have the hotel-specific experience you need for your

hotel matters, then find a way to get it! We would be glad to

discuss with you how the experience we have gained over more

than 35 years and more than $123 billion of hotel transactions

might provide exactly the guidance or power you need to get the

result you want.

The HMA & Franchise Agreement Handbook

Getting started — terminology

Here is something of a glossary for deciphering the coded terms

used with HMAs and franchise agreements:

Hotel managers and hotel operators. In the hotel industry, the

professional companies that operate hotels are interchangeably

referred to as hotel managers, hotel management companies,

hotel operators, or hotel operating companies. These terms have

the same meaning, and for a little variety, we may use these terms

interchangeably.

A hotel brand, branded management and independent

operators. A hotel brand company owns the trademark,

tradename and other protected intellectual property rights

associated with the brand's use in the hotel industry. This hotel

brand company may or may not be associated with a hotel

management company. For example, Marriott, Hilton,

InterContinental, Hyatt and many other hotel companies own the

intellectual property associated with one or more brand names.

They can independently license the use of their brand name under

a license or franchise agreement, or include the right to use the

name in the HMA when they manage a hotel.

Hotel companies that own these brands are often called "the hotel

brands" or just "brands." Some of these brands, such as Choice

Hotels and Best Western, only license their brands and do not

operate hotels. Other brands which offer hotel management

services are usually called branded operators or branded hotel

managers. They often manage some of their brands but not others.

In contrast with branded hotel operators, a large number of hotel

operators do not own or do not license any hotel brands to

identify hotels to the public. Instead, they specialize in operating

hotels (either branded under some other company's franchise or

unbranded). This latter group of operators without brands are

often called independent operators as they are independent of the

traditional hotel brands.

Hotel Management Agreements (HMAs) and their ilk. Contracts

between hotel owners and hotel operators controlling the

management of a hotel go by various names. They are called hotel

The HMA & Franchise Agreement Handbook

xii

management agreements, HMAs, hotel management contracts or

hotel operating agreements. For convenient reference, in this

book, we will generally use the term "Hotel Management

Agreement" or "HMA." Again, each of these terms means the

same thing.

HMAs allocate risk. Whatever they are called, Hotel Manage-

ment Agreements allocate risk between the hotel manager and the

hotel owner. Many provisions in the HMA do this, including

reimbursement obligations, termination rights, performance

standards, indemnification obligations, and subordination

provisions. One type of "subordination" is an economic

subordination, as where a manager agrees that all or a portion of

its base or incentive fee will be subordinated (paid only after) to

an owner's preferred return. Another type of subordination is

discussed below under SNDAs.

Franchise or License Agreements. When brands grant the right

to operate a property under a brand name, they do so under a

franchise agreement, which is also often interchangeably referred

to as a license agreement. In this book we generally use the terms

"franchise" and "franchise agreement," but we might just as well

have used "license" and "license agreement" as these terms mean

the same thing. Whatever label is used, franchises are regulated

by the Federal Trade Commission. In many cases they are also

registered with state regulators and are subject to a number of

disclosure requirements and substantive regulation. Franchise

agreements are traditionally less negotiable than management

agreements, but as we discuss in Chapter 3, a number of very

important terms can be negotiated.

SNDAs. SNDAs are agreements between a hotel operator and a

hotel mortgage lender governing the lender's right upon a

foreclosure on the hotel, including protection of the hotel

manager's right to continue to manage the hotel after foreclosure.

For our purposes the following three terms are identical in

meaning and fully interchangeable in the context of hotel operat-

ing agreements: SNDA, Subordination Agreement, or Subordina-

tion, Non-Disturbance and Attornment agreement (from which

the SNDA acronym is derived).

The HMA & Franchise Agreement Handbook

xiii

Subordination Agreements are frequently used with various

types of real property when someone other than the owner is

occupying or using the property secured by the lender's loan. In

the hotel industry, this arrangement involves the hotel owner, the

hotel operator and the hotel lender. Since the lender's joint

agreement is required, typically the HMA will specify that these

three parties will execute an SNDA (as a free standing agreement)

prior to placing any lien on the hotel. The terms of the SNDA may

be specified in the HMA, set forth in an attached exhibit, or

required to conform to the requirements of the hotel operator.

SNDAs are potentially so important that we have devoted an

entire section to them, and several sections refer to them. (See

SNDAs or Subordination Agreements affect the value, financeability,

and collateral value of a hotel, page 58).

Comfort Letters. Brands generally do not enter into SNDAs for

franchised properties; they enter into (and lenders typically

require) "comfort letters," which are agreements that define the

rights of lenders and the brand if the owner defaults under a loan

secured by a franchised hotel. These agreements can have a

meaningful impact on the terms that an owner may obtain from a

lender, or on a lender's rights in the event of a default.

Considerable care should be given to negotiating their terms. (See

The importance of Comfort Letters in financing franchised hotels,

page 80.)

HMAs and franchise agreements can dramatically affect the

value, financing, operations, and marketability of a hotel.

This HMA & Franchise Agreement Handbook addresses a broad

range of subjects on how to get a great operator and hotel

management agreement, critical terms of a hotel management

agreement, and how to terminate a bad hotel operator. It will also

cover selecting the right brand, negotiating a franchise agreement,

selecting an independent operator, and important comfort letter

issues.

The HMA & Franchise Agreement Handbook

xiv

About the authors

Jim Butler is one of the top hospitality lawyers in the world

(Google™ "hotel lawyer" and you will see why).

Jim is the author of the Hotel

Law Blog and Chairman of

the Global Hospitality

Group® at Jeffer Mangels

Butler & Mitchell LLP

(JMBM). For more than 35

years, Jim and his team have

helped hotel owners,

developers, investors and

their lenders find business

and legal solutions with their

unequaled hotel experience

gained over more than $123 billion of hotel transactions, involving

more than 4,600 properties all over the world.

Jim and his team are more than "just" great hotel lawyers. They

are also hospitality consultants and business advisors who help

clients unlock and preserve value in hospitality properties.

The hotel management agreement and franchise agreement are

intertwined with virtually every legal and business aspect of your

hotel. They are the keystone affecting the most crucial

components of your hotel's success, including financing, owner-

ship structure, value and profitability, day-to-day operations and

guest perception.

JMBM's Global Hospitality Group® has negotiated, re-negotiated,

litigated and advised on more than 2,700 hotel management

agreements and franchise agreements. We have current, state-of-

the-art experience in successfully negotiating with virtually every

major hotel management company and most of the independent

operators.

A structural pillar of our hospitality power is our dominant

management agreement and franchise agreement expertise.

The HMA & Franchise Agreement Handbook

Whether it is a troubled investment or a new transaction, JMBM's

Global Hospitality Group® creates legal and business solutions

for hotel owners and lenders. They are deal makers. They can help

find the right operator or capital provider. They know who to call

and how to reach them.

Jim Butler

[email protected]

310.201.3526

Bob Braun is a transactional

lawyer who has negotiated

hundreds of hotel man-

agement, franchise and license

agreements for owners,

developers, investors and

lenders. A senior member of

the Global Hospitality

Group® at Jeffer Mangels

Butler & Mitchell LLP, Bob

represents hospitality clients

in both transactional and

operational issues.

On a domestic and international basis, he is experienced in nego-

tiating hotel management and franchise agreements, the purchase

and sale of hotels, resorts, restaurants and other hospitality

properties, providing counsel for a wide range of strategic and

operational issues, and helping clients with troubled assets.

The agreements between the owner, brand and manager affect

virtually every aspect of the hotel or resort property. Bob brings

to the negotiating table a wealth of experience in hotel

transactions and a deep understanding of the day-to-day

operating issues of hotels and resorts, and related operations such

as spas, restaurants, retail, residential components, golf courses

and more).

Bob's recent experience includes negotiating the management

agreement for a European mixed use development, including

multiple hotels and food and beverage outlets, as well as

The HMA & Franchise Agreement Handbook

xvi

residential, retail and commercial components; dual-branded

luxury, upper upscale, upscale and extended stay properties;

negotiating a management agreement for a mixed-use office,

retail and ultra-luxury hotel property in a major metropolitan

area; and facilitating the acquisition and branding of a series of

hotels acquired by a lender in foreclosure. Bob has handled a

transfer of management for a portfolio of 27 hotels to six separate

management companies (and negotiated the related franchise

agreements); represented the acquisition and assembly of a

portfolio of 10 full-service and select-service hotels by an

internationally recognized private equity group; and has over-

seen dozens of friendly and hostile transfers of brands and

management of distressed hotel properties. Bob has also worked

with clients to renegotiate and, in some cases, terminate HMAs

and franchise agreements. As Co-Chair of the Jeffer Mangels

Butler & Mitchell Cybersecurity and Privacy Group, Bob

frequently advises clients on state, federal and international

privacy, cybersecurity, data breach and information technology

matters, and negotiates software, internet, e-commerce, data

processing and outsourcing agreements.

Bob and JMBM's Global Hospitality team have decades of exper-

ience in helping owners preserve and enhance the value of their

hotel properties through hotel management and franchise

agreements. They are advocates who can level the playing field

between hotel owners and hotel brands.

More than just great lawyers, the members of the Global

Hospitality Group® are deal makers who bring solutions to every

situation.

Bob Braun

[email protected]

310.785.5331

The HMA & Franchise Agreement Handbook

xvii

Mark S. Adams focuses his

practice on business litigation,

including, contracts, products

liability, corporate and

partnership disputes, and

hospitality litigation. He

regularly litigates high-stakes

shareholder and investment

disputes. He has significant

litigation experience in rep-

resenting real estate devel-

opers and real estate investors.

Mark has successfully litigated many high profile cases on hotel

management agreements and franchise agreements, fiduciary

duty issues, investor-owner disputes, TOT assessments, and other

hotel-specific issues.

Mark has wide-ranging trial experience in commercial disputes,

including complex multi-party litigation and class actions. He has

tried numerous cases in state courts, federal courts, and in

domestic and international arbitrations, and is a frequent author

and speaker on trial practice. Mark's trial wins have been covered

by Forbes, Reuters, Life Science Weekly and other publications. He

has obtained two of California's annual 50 largest jury verdicts in

the same year. Mark has taken or defended nearly 1,000

depositions throughout North America, Europe and the Middle

East.

Mark S. Adams

[email protected]

949.623.7230

CHAPTER 1

HOW TO

GET A GREAT

HOTEL OPERATOR

The HMA & Franchise Agreement Handbook

Maximizing hotel value with

management, branding and

franchise

magine this: You are getting ready to start one of the most

important processes in your hotel's "life cycle" — selecting the

hotel brand and operator and getting them under contract. Even

if you are a major hotel owner or developer, how many

management or franchise agreements do you do a year? Two?

Five? Ten? And with how many brands?

Or, maybe you are a very experienced real estate developer or

investor, but you haven't done many hotel deals, and don't want

to fall into the traps some other smart real estate investors have

when they failed to realize that hotels are different. You need to

know (or have a guide to) the players, the norms and customs,

and the practices of the hotel industry. How can you do that?

With JMBM, no one will make a fool of you. Our experience will

help you confidently establish what is "market" on management

or franchise agreement terms. We will help you strike a good deal

and a fair one.

What if you could make one phone call to solve your problem?

One phone call to instantly tap into these resources:

The "little black book" of hotel industry contacts of a

hotel industry insider, complete with relationships and

credibility built over more than 35 years.

A virtual data base of terms and deal points gathered

over more than two thousand transactions with virtually

every brand and operator, so you know when you are

getting "market" terms.

Top business advisory and legal guidance and protec-

tion at every step.

These are precisely the resources you can access with the

hospitality attorneys of JMBM's Global Hospitality Group®. We

have negotiated, re-negotiated, litigated and advised on more

The HMA & Franchise Agreement Handbook

than 2,700 hotel management agreements and franchise

agreements.

Hotel management and franchise agreements are intertwined

with virtually every legal and business aspect of your hotel. They

are the keystone affecting the most crucial components of your

hotel's success, including financing, ownership structure, value

and profitability, day-to-day operations and guest perception.

In fact, a branding and management agreement can easily create

more than a 50 percent swing in the value of the hotel — and often

much more! And, a long-term management or franchise

agreement is difficult to "fix" once it is in place.

We can help you develop your own list of deal point priorities

that you "must have," "want to have" and "would like to have."

These may include a host of critical items, such as: performance

clauses, termination rights, ramping up management fees, owner

approval rights over operating and CapEx budgets, preferred

returns for owners, and subordinated incentive fees for operators.

JMBM's Global Hospitality Group® has successfully negotiated

with virtually every major hotel management company and

brand. Our vast experience helps create value for your project.

The HMA & Franchise Agreement Handbook

Three of the most important things

you will ever do for your hotel

hree of the most important things you will ever do for your

hotel are selecting the right hotel brand, selecting the right

operator, and negotiating a fair Franchise Agreement and/or

Hotel Management Agreement.

At one time, virtually all of the upscale hotel brands were only

available with a hotel management agreement. In this model, the

hotel company grants the hotel the right to use its brand as part

of the HMA that also gives the hotel company the sole and

exclusive power to manage the hotel for a period of many years.

There is no franchise or license agreement. In this arrangement,

when you select the brand, you have selected the operator because

there is a unity of brand and brand management. Although the

power of the brand and effectiveness of operations are still

separate considerations, ultimately the selection of one

determines the other. This model of the so-called branded

management agreement continues to be important today,

particularly for luxury and upper upscale hotels, as well as hotel

assets that are strategically important for a brand.

But over the last 20 years, particularly with the success of select

service product, the alternative of the franchise model has spread

from its economy segment roots. In fact, it has become prevalent

for significant segments of the hotel industry, including full-

service and upscale hotels. It was once unthinkable that an owner

could franchise a Hyatt, Westin, JW Marriott or the like, but such

franchises are now growing more common by the day as the

major hotel companies embrace the franchise model.

In this franchise model, the selection of a brand is a completely

separate process from the selection of an operator. Separate agree-

ments will be required — a franchise agreement to get legal rights

to use the brand to identify the hotel and an HMA to get an

operator for the hotel property.

The successful matching of the brand and operator with an asset

and its owner is an important determinant to the success of a hotel

project. Finding the right brand and operator for your project —

The HMA & Franchise Agreement Handbook

and achieving reasonable terms in your franchise agreement and

HMA — can make a significant and positive impact in key areas:

hotel value, financing, and operational success. If you make a

mistake, it is almost impossible to correct.

The terms of a branding and hotel management agreement can

add — or subtract — a huge amount of value. As noted earlier, it

is widely recognized that the business and legal terms of these

arrangements — wholly apart from the operator's abilities — can

create a 50 percent or more change in the value of the hotel. That

is huge! Take a hotel nominally worth $100 million. By this

industry rule of thumb, the hotel's value could easily swing $50

million (from $75 million to $125 million) depending on the brand

franchise and/or management contract terms.

We have seen many situations where the ability to terminate a

long-term hotel management agreement added significant value.

In one recent case we handled, it added $41 million dollars to one

luxury hotel. We have also seen cases where the ability to

terminate would have doubled the value of the hotel, or at the

very least, added $50 to $65 million to the value of the property.

Aside from the right "marriage" partners, the terms of the

franchise agreement or management contract tying brand and

management together is critical, because it will likely govern the

relationship for decades and is hard to change once cast.

Impact of brand and operator on financing

Many lenders will not consider lending on hotels unless they are

branded, and they may even have certain preferred brands and

operators.

But a hotel management agreement can also effectively prevent

financing or refinancing a hotel. Sometimes the contract requires

operator approval for any financing, or prohibits leverage above

certain specified levels. Sometimes a lender's inability to

terminate the HMA on loan default will deter financing or

otherwise raise the cost and adversely affect the terms of a

financing.

The HMA & Franchise Agreement Handbook

Owners should not assume that operator approvals will be given

if they are discretionary, and should not underestimate the impact

a management contract can have on a lender or investor.

Sometimes, the brand itself is not financeable.

Operators' and HMAs' effect on hotel operations

Under most branded hotel management agreements, the operator

will have almost exclusive control over all aspects of a hotel

property and operation — hiring and firing hotel personnel,

setting rates and policies, sales and marketing, renovations,

capital expenditures, collecting revenues and depositing them

into accounts controlled exclusively by the operator.

Brand costs. Maintenance of brand consistency and power often

varies. Brands and their reservation systems ebb and flow in their

quality and ability to deliver room revenues. Brands have great

power unilaterally to impose changes in standards that all system

hotels must meet — new computer systems and software, new

signage and logos, new or revised traveler loyalty programs,

design requirements, promotions, and centralized services. Hotel

owners frequently come to believe that the cost of these brand-

imposed standards are simply not worth the benefit. Or they think

the standards benefit the brand, but not the hotel.

Owner approval rights. The owner's ability to control runaway

costs and require appropriate efforts to drive the top line, when

necessary, largely depend upon "approval rights" over critical

matters like annual operating budgets, marketing plans, capital

expenditures, entering into union or other major contracts,

personnel hiring and benefit plans, and operator self-dealing.

New brands. Over the last decade or two, many brands and

operators expanded so rapidly or acquired so many brands that

they were unable to make meaningful brand distinctions for the

consumer market. They appeared to lack the procedures, systems,

personnel, and expertise necessary to properly manage all the

new hotels brought under the flag. Or optimistic projections for

brands reaching critical mass and economies simply failed to

materialize. Sometimes regional offices were not staffed or have

been closed. In some cases national sales and group marketing

were either never well-developed or inadequately maintained.

The HMA & Franchise Agreement Handbook

Brand changes. We have seen many owners despair when the

branded operators they signed up with subsequently changed

their ownership, market position or strategies. Red Lion was once

a very strong 4-star brand. RockResorts was founded as a chain of

small luxury hotels that after initial growth, declined to only one

hotel. Amfac was one of the fastest growing brands in the United

States and was in the top 25 hotel management companies, until

it sold and spun off most of its hotels to become a campground

operator. Wyndham underwent dramatic changes when sold to

Blackstone and later spun off, as did Doubletree when acquired

by Hilton. Same with Le Méridien after the sale by Air France.

How would you like to be one of the hotels locked in under a long-

term, no-cut branded management agreement with a "lost" or

"drifting" brand in transition for several years, if not eternity?

It's almost impossible to fix a bad choice in brand,

operator or contract terms

Branded hotel management contracts tend to be very long-term

agreements. While it depends on the brand and your bargaining

power, 30-50 years is not uncommon, and some run to 100 years!

Sometimes it is possible to negotiate amendments or changes to a

long-term HMA. A few operators might agree to amendments out

of a sense of fairness when they are not able to deliver on promises

made, or when faced with extraordinary circumstances, such as a

pandemic or economic crisis. But that is not very common.

Usually, operators demand the strict enforcement of the contract

terms, unless there is some mutual benefit (such as additional

investment by the hotel owner) or a trade-off of value for value.

Virtually none of the branded HMAs are terminable at an owner's

option — unless you negotiated for that point. So the operator will

have almost exclusive control over your hotel for many decades

unless you can negotiate an amicable buy out or termination of

the contract. Some operators may do this, but it is unlikely to be

cheap. And most operators will likely refuse to do anything to

shorten their long-term contracts.

You have relatively few alternatives except to establish a material

breach of contract or a breach of fiduciary duty by the operator.

The HMA & Franchise Agreement Handbook

Of course in some circumstances, you might be able to just breach

the contract yourself and terminate the operator, but you will be

liable to the operator for damages likely equal to the present value

of the profit the operator would have received under the HMA for

the remaining term. And, under appropriate circumstances, you

might file bankruptcy and reject the HMA in the bankruptcy

proceeding.

Like we said, HMAs with the branded hotel companies are very

difficult or almost impossible to fix once they are in place.

So how do you get the right brand and operator for your hotel

project ... and a deal you can live with?

There is a way to enhance greatly your prospects to get the best

brand for your project and a fair deal on your HMA.

First, you need to avoid the five biggest mistakes hotel owners

make in selecting operators and negotiating HMAs. (See page 9)

Then, you need to understand and run a professionally guided

HMA PRO™ to recruit a great operator while making the terms

of the HMA one of the key ingredients in selecting the operator.

The HMA PRO™ is described in the section that begins on

page 18.

The HMA & Franchise Agreement Handbook

The five biggest mistakes hotel owners

make in selecting operators and

negotiating brand HMAs

e have found that hotel owners who get into bad situations

with their operators usually fall into one or more of five

traps for the unwary. The following are the five biggest mistakes

owners make when seeking an operator or brand for their hotel,

and the "famous last words" that accompany them:

Mistake #1:

Famous last words:

Focusing on just one brand

and letting them know you

"have" to have them.

I just have to have Brand X

for my hotel. They are perfect

for my project.

Even if Brand X is perfect for your project, the best way to get a

great brand and a fair deal is to have a little competition, compare

the results, and be sure each operator knows there is at least one

other brand they have to "meet or beat." This process should not

feel like an auction, but rather like the controlled, selective,

competition that it will be. (See the sections on HMA PRO™ on

pages 18 and 22.)

Mistake #2:

Famous last words:

Trying to do it yourself — the

biggest false economy of all.

You don't know what you

don't know.

We met some operators at

the recent hotel conference,

and they really like our

project. I think we can do a

deal with them. Or ... maybe

you can just give me a couple

more phone numbers to call.

A casual or accidental process is not the best way to identify,

recruit, and selectively draw out the best business and legal terms

for your hotel management agreement. You will have already

given up more than you know over cocktails or a round of golf in

an undisciplined process. Hotel executives make their living by

negotiating hundreds of deals with people like you. Without

The HMA & Franchise Agreement Handbook

identifying all your project's strong points at the outset and

drawing the blueprint for your HMA PRO™ (the ultimate

refinement of an RFP-like process for getting a hotel operator and

fair HMA terms), your deal will get shopworn and tired before it

can be properly positioned. And if you let the hotel companies

guide the process, you may find yourself with a Letter of Intent

(LOI) or term sheet before you have guided and shaped the hotel

company's expectations. As a result, owners can lose big,

important "deal points" that could have been accomplished if they

had engaged in a disciplined process.

Mistake #3:

Famous last words:

Starting to get proposals

from a brand or operator

thinking it expedites the

process and saves money.

Let me get the LOI signed

first. It's 'non-binding'

anyway. Then we will bring

in the management

agreement experts.

It is a false economy — usually a near disaster — to negotiate the

LOI terms first, and then bring in your hotel management

agreement advisors. By the time the LOI has been discussed,

much less signed, it is too late to protect your interests. Although

most LOIs say they are non-binding (except on exclusive dealings

with only the one operator and on confidentiality), the custom of

the industry is that you are "retrading" the deal if you try to

change those "non-binding" terms or address new issues when

your experts try to un-ring the bells that you have set off. Yes, you

could probably walk from the deal (after waiting out the

exclusivity period), but you have now lost the ability to do a

reasonable deal with the operator you thought would be best, and

you have lost time and momentum. The operators are well aware

of this, and they usually will not retrade.

Mistake #4:

Famous last words:

I will align the operator's

interests with mine by

getting the operator to invest

in the deal. (Uh-Oh!)

We have the operator's

interests aligned with ours.

They are making an

investment in the deal, along

with us.

The HMA & Franchise Agreement Handbook

At first it is exciting. The operator thinks so highly of your project

that this major institutional, experienced operator is actually

willing to co-invest with you in your project. Be forewarned: the

operator's money will be the "most expensive" capital an owner

can get — not in terms of the return paid on the capital, but in the

terms you will have to "give up" in the management agreement.

The operator will still get its real money off the top before any

return is paid to equity.

Mistake #5:

Famous last words:

Let the hotel operator take

care of everything — HMA,

design, budget ... They are

the hotel experts and you

can focus on the other

important stuff.

I don't care about the hotel

management agreement

terms. I just need someone

to take over the hotel aspects

of the deal so I can do my

retail … office … golf …

course … condos. I'm not a

hotel guy.

Our typical client is very successful in business, perhaps even in

real estate or development. But many of our clients are novices

when it comes to hotel development, management agreements

and operational issues. For these people, it is usually better to

temporarily hire the team of experts needed than to turn the hotel

issues over to someone in the organization who has neither hotel

experience nor the same commitment to the project.

How to avoid these mistakes

Hotel owners and operators need each other. Although some

tension always exists in the push-pull of owner-operator rela-

tions, in many situations owners and operators share the same

vision of what a hotel should be, how it should operate and how

to make it a smashing success.

At the other end of the spectrum, there are miserable hotel owners

who have great operators "locked in" on terrible 50-year, no-cut,

operator-takes-all management agreements. Other unhappy

owners have great management agreements with operators who

cannot execute the business plan or deliver on financial or guest

expectations.

The HMA & Franchise Agreement Handbook

How do you get the "Goldilocks" balance (not too hot, not too

cold, but just right) of a great operator, a shared vision for the

property, and fair management contract terms?

Over the years, we in JMBM's Global Hospitality Group® have

developed our version of the hotel brand and operator RFP

process. We call our optimized process the HMA PRO™ for Hotel

Management Agreement Procedure to Recruit (a great) Operator.

The HMA PRO™ is an organized, disciplined and highly

interactive process. It's not about "putting your project out to bid."

It's about strategically positioning your property to attract the

right operator for you and your project. Here's how it works:

Based upon the owner's goals, the specifics of a project and its

market fundamentals, we first identify an exhaustive list of

possible brand and operator candidates. With the client, we

review and prioritize choices, and compare alternative operator

contacts and approaches, tailoring them to the individual project

and operator candidates.

Unlike RFPs for many other purposes, we generally recommend

that the owner plan to actively "sell" the merits of the project to

the brand and operator candidates: tell them why this is a great

project that they want to have in their family of hotels. Clarify

your vision of what distinguishes the project, how it will be

successful, and why it may be strategically or financially

important to their particular hotel company.

Careful planning and execution of the HMA PRO™ is one of the

most important keys to finding a good hotel operator and brand

and getting a fair agreement — and one you can live with for

many years!

The HMA & Franchise Agreement Handbook

How to get a great hotel operator and

a fair hotel management agreement

Why hotel owners need HMA PRO™

veryone agrees that the choice of the right hotel brand and

operator may be one of the most significant decisions

affecting the financial success and value of a hotel. The right

operator will add significant value to the property, both on a

current basis through better operations, and by enhancing the

long-term value of the property. At the same time, the wrong

brand or the wrong operator will reduce the current earnings of

the property and the value of the property, making it harder to

finance and resulting in a lower sales price.

Successful hotel investment also requires a fair HMA

Many owners discover too late that getting a great operator is only

a part of the puzzle they need to solve. Investors also need a fair

hotel management agreement or HMA. Without a fair HMA, the

best operator in the world will not bring the expected benefits to

the hotel investment.

The typical branded HMA is a one-sided agreement in favor of

the brand and against the interests of the owner. Wholly apart

from the fees and other economic terms, the operator has virtually

total control of the hotel while making the owner responsible to

maintain the operator's vision of its operating standards —

without regard to the owner's needs.

We sometimes say that such an agreement gives the operator "all

the benefits of ownership without any of the burdens."

Using HMA PRO™ to get both a great

operator and a fair HMA

We are convinced that the solution to getting the best hotel brand

and operator — in terms of an HMA that is fair to all, including

the owner — is a process we have refined to a new level and which

we call the Hotel Management Agreement Procedure to Recruit

(a great) Operator or HMA PRO™.

The HMA & Franchise Agreement Handbook

HMA PRO™ is JMBM's refinement of the old standby Request

for Proposal or RFP. We started with the typical RFP process still

used by knowledgeable hotel consultants today. However, we

didn't like the passive nature of the RFP process, which suggests

that the owner should just wait for whatever an operator might

propose. Thus, over a period starting more than 35 years ago, we

made some critical changes to the typical RFP process that greatly

enhance the outcome for owners and investors. We don't know

anyone else who uses a unique process like ours, and we decided

that our proprietary process needed a different name to

distinguish it from what everyone else does. So we coined the

phrase HMA PRO™.

When to bring in the hotel advisors

The best time to bring in experts is at the very beginning of your

project, when you are evaluating, planning and structuring. We

are like the legal and business architects helping you develop the

blueprint for your hotel transaction strategies. And everyone

knows that you call in the architect before starting construction.

You want the architect's experience to help develop concepts, test

feasibility of certain approaches, and ultimately to prepare the

blueprint to guide your very first steps.

Identifying the owner's goals and priorities

Before recruiting a hotel operator, each owner must identify,

evaluate and prioritize its goals and other considerations for a

particular hotel. What does the owner want to accomplish with

the property? How do relative advantages of alternative posi-

tioning compare? How do the ultimate ownership goals stack up

against realistic alternatives? Each owner must consider its

current and potential plans.

For example:

 Is this to be an iconic trophy property or a less attrac-

tive but perhaps more reliable cash generating

machine?

 Must the profit and capital appreciation come from

the hotel itself, or from greatly enhanced value in a

The HMA & Franchise Agreement Handbook

resort, integrated mixed-use components or adjoin-

ing residential, office or retail properties?

 What resources and capital is the owner prepared to

dedicate to the project?

 Is the investment horizon short-term or long-term?

Is it driven by any particular events or by economic

return or other factors?

 How does this property fit in with other investments

in the owner's portfolio? What is the cost-benefit

analysis for alternative positioning?

Don't even start talking to operators

until you have a grip on the 50-point

comprehensive HMA PRO™ checklist!

Before your first contact with a hotel operator, you should care-

fully identify all of your unique ownership priorities and goals.

We help clients accomplish this by walking them through our

comprehensive HMA PRO™ checklist (See page 18). In almost

every case, it changes the operators you want to approach, how

you approach them, and what you want to accomplish from any

exchange with operators.

It usually takes several hours of focused discussion to work

through the business and legal points in the comprehensive HMA

PRO™ checklist, and most clients find this time to be some of the

most valuable in the entire process of recruiting a great operator.

The checklist is a detailed list of 50 tier-1 and tier-2 business and

legal issues which an owner needs to resolve prior to or during

the earliest stages of negotiating the term sheet or letter of intent

(LOI) with the operator. We call these matters tier-1 for "must

have" deal points, and tier-2 for "really want to have" matters that

perhaps are not as crucial, but are still extremely important. The

tier-3 issues are more mechanical items that can be hashed out in

the actual negotiation of the hotel management agreement itself,

after the term sheet or LOI is finished.

The HMA & Franchise Agreement Handbook

People outside the hotel industry often don't realize that the

owner's ability to negotiate for these tier-1 and tier-2 checklist

items will be jeopardized or lost once the back-and-forth of the

LOI negotiations have begun. They find themselves drawn into a

seductive process of negotiations with proposed operators,

thinking no harm can come from getting a "non-binding" term

sheet with an operator, and they will have the hotel experts look

it over later on.

But beware! Once the first requests or comments are given by the

owner to an operator proposal (even though "non-binding"),

operators typically will say that the owner is "retrading" the deal

if it then tries to raise these issues later on, and operators normally

will not discuss these issues further even though they might have

agreed to them if "properly" sequenced. What good does it do to

have hotel experts look at the non-binding deal that cannot be

changed on any important business or legal terms? You can

basically "take it or leave it" on the non-binding deal you struck,

but you may have lost an operator that would have been the best

for your property.

While some operators may cut a little slack in this situation, most

do not. And even with the more flexible ones, every deal point

will be harder fought and more compromised. It is better to avoid

being put in such a position of weakness.

How is HMA PRO™ different?

We developed HMA PRO™ because we observed that the

traditional RFP did not create a competitive, owner-oriented

process. The name itself, RFP or "request for proposal," puts the

owner in a passive position and does not encourage the owner to

shape the proposals for its maximum benefit.

HMA PRO™ is a different and unique solution. It relies on early

identification of the owner's key concerns, and then approaches a

small handful of pre-selected candidates who are more likely to

meet the owner's needs, rather than using a shotgun approach. It

does not treat operators like fungible commodities. Rather, it

recognizes that each operator brings different strengths and

qualities to a management opportunity. We have found that this

approach makes operators more willing to participate in HMA

The HMA & Franchise Agreement Handbook

PRO™ than an RFP. An RFP often makes operators feel like they

are wasting time and resources on an auction where they have

little chance of success. HMA PRO™ lets each operator know it is

special, encourages participation and focuses the parties on

critical elements, mutual expectations and terms, rather than

platitudes and advertisements.

It is a better and more focused process that uses everyone's

precious time more efficiently.

Seven basic steps in the HMA PRO™ process

Our HMA PRO™ process has seven basic steps for identifying

and contracting with the optimum operator:

1 Establish and prioritize the owner's needs and goals, and

develop strategies and approaches to achieve them.

2 Identify the brand and operator candidates most likely

to meet the owner's needs and goals.

3 Recruit the best brand and operator candidates by

developing a package and approach to "sell" the merits

of the project, generate operator interest with direct

contact at the appropriate level, and gain buy-in to the

HMA PRO™ process.

4 Draw candidates into a constructive, interactive process

with on-site property inspections and mutual

presentations by operator and owner. Elicit a proposal

from each candidate that is responsive to owner's

priorities.

5 Evaluate the business and legal elements of each

proposal received to select the "finalists" for a "best and

final" process.

6 Seek "best and final" proposals and analyze them to

identify one party to negotiate with until a deal is

reached (and if a deal cannot be concluded, move on to

the first alternate).

7 Negotiate to conclusion and execute final agreements.

The HMA & Franchise Agreement Handbook

HMA PRO™ Checklist

he following is our comprehensive HMA PRO™ checklist,

and most clients find time spent reviewing this checklist can

be some of the most valuable in the entire process of recruiting a

great operator. This list is intended to include the full range of

what a hotel might consider asking for; each situation is different

and some of these terms will be more than specific operators are

willing to give.

HMA PRO™ CHECKLIST

Subject

Provision



Term

Initial term

Renewal terms

Fees

Base fee

Incentive fee

Fee caps

Subordination of fees

Alignment of

Interests,

Operator

Incentives

Shared investment

Credit enhancement

Key money

Net operating income or gross

operating profit guarantees,

guarantees against negative

operating cash flow —

guarantee, letters of credit or

revolvers provided by operator

Joint venture structure issues

The HMA & Franchise Agreement Handbook

HMA PRO™ CHECKLIST

Subject

Provision



Operator

Duties

Detailed listing of operator

duties

Limits on operator authority

Control over reimbursements

(such as markups, overhead

and travel) and complimentary

rooms

Termination

Termination for cause

Termination on sale

Termination for failure to satisfy

the performance standard

Termination for convenience

Termination for failure of brand

to maintain: growth trend,

critical mass, regional or

national marketing

Termination for bankruptcy or

insolvency of brand

Termination for deterioration in

brand or public perception

Termination for brand's change-

in-control or change in key

personnel

Termination by owner for failure

or inability to open, get

financing, operate profitably,

reopen after disaster if

expenditure of more than $xx is

required)

Transition on termination

The HMA & Franchise Agreement Handbook

HMA PRO™ CHECKLIST

Subject

Provision



Performance

Tests

RevPAR test

Budget test

Owner's Return test

Two-prong or single prong test

Measuring period

Cures

Provision enabling owner to

explore other operators at any

time it is uncomfortable with

operator, in its sole discretion

(no interference or breach)

Operating

Standard

Fiduciary obligations, maximize

net present value to owner,

minimize obligation of owner to

provide additional investment

Budgets

Content

Timing

Operating budget approval

Capital budget approval

Budget compliance

Reports and

Inspection

Periodic reports, annual reports,

detail and flash reports

Audited financial statements

Right of owner to inspect and

audit both financials and

operations

The HMA & Franchise Agreement Handbook

HMA PRO™ CHECKLIST

Subject

Provision



Other

Matters

Who is the employer?

Union matters

Licenses and permits, including

liquor license

Subordination, Non-Disturbance

and Attornment agreements

with lenders now and in the

future

Limitation on owner

contributions to working capital

Right of first refusal

Non-Compete term, area,

brands

Indemnification — what

exclusions to owner's

indemnifications of operator

Exculpation — limit liability of

owner to its interest in the hotel

Sale of the hotel — operator's

transfer of rights under the

hotel management agreement

— what restrictions or approvals

Court system, judicial reference,

arbitration and expert resolution

The HMA & Franchise Agreement Handbook

How to make your HMA PRO™

successful — a practical guide

n selecting and signing up a branded operator, the first step is

to recognize that this is a big event. Remind yourself of that

every day.

Think about the magnitude of the opportunity ... and the hazard.

Once you are firmly focused on the importance of the task at hand,

act accordingly. The next step is to round up and dedicate the

necessary resources for this important job — internally and

externally. You want experienced hotel experts who have been

through the process hundreds of times to guide you through a

process for identifying and recruiting the best operator for your

hotel.

Selecting the right branded hotel operator is NOT something you

do casually, quickly or without expert advice. It takes planning,

strategy, analysis and game plan execution. The payoff is big. The

consequences are severe.

HMA PRO™ is NOT a form —

It is an interactive process

We are sometimes asked by well-meaning friends or clients if we

can just give them a form for an HMA PRO™. That is the tipoff

that someone needs some more background information to

understand what an HMA PRO™ really is and how to make it

work. Here is what we tell them:

First, the HMA PRO™ is a process and involves some important

documents. Both the process and the documents should be

carefully integrated to address all the relevant business, legal and

hotel industry issues. We don't pull it off the shelf because it needs

to be customized to your situation after the all-critical business

judgments are formed. (After doing more than a thousand of

these, the documents are the easiest part of the exercise!)

The process and documents can look very different from deal to

deal, and combine or separate important steps. The business, legal

and hotel aspects all have to be brought into focus, well before

The HMA & Franchise Agreement Handbook

documentation. The hotel lawyers at JMBM don't just document

the deal, we work to get you the best deal. The HMA PRO™

process is a great strategy for positioning your project to get the

best terms possible.

What happens in the HMA PRO™ process?

How the HMA PRO™ process is shaped — i.e. how many steps

are involved, how much information is provided (and when), and

whether you "sell" the deal first to raise enthusiasm, and other

elements — depends on the unique considerations in each deal.

The process is likely to include these elements:

 Identifying appropriate candidates to brand and

operate the hotel project

 Preparing a tailored presentation for owner to

present to the operator candidates explaining the

opportunity in general terms to gain interest and

participation

 Soliciting an indication of interest in participating in

the HMA PRO™ or discussions with the owner-

developer

 Requesting a confidentiality agreement in order to

receive further information

 Providing different levels of information to HMA

PRO™ candidates in two or more stages

 Granting access to a "due diligence room" or

providing a "book" of information and exhibits

 Marketing to potential HMA PRO™ participants to

whet their appetites, create excitement for the

project, and show them how much there is to gain if

they reach to get the deal

 Collecting, reviewing and analyzing proposals

 Preparing comparative summary of key aspects of

each proposal (the "matrix")

The HMA & Franchise Agreement Handbook

 Requesting clarifications of proposal deal points

 Running an interview process with selected finalists

leading to a "best and final" proposal process

 Ultimately, negotiating and preparing final docu-

mentation with a selected candidate or two

Careful planning and execution of the HMA PRO™ process is one

of the most important keys to finding a good hotel operator and

brand and getting a fair agreement. Whether your project is a

standalone hotel or a hotel mixed-use development — getting the

right operator or brand, and a deal you can live with, is critical to

the success of your project.

The HMA & Franchise Agreement Handbook

How to negotiate an HMA

Ten tips for a smoother process

e get a lot of calls to help owners, developers, and investors

negotiate new hotel management agreements. One of the

first questions they usually ask is how the negotiation process

works, since there are so many different parties involved, usually

in different parts of the country (or the world).

So, this section will focus on the process of negotiating the hotel

management agreement. How do you effectively gather and

coordinate the input from all relevant stakeholders and advisors?

How do you communicate the right message to the operators and

drive the process to a timely conclusion with a good result for the

owner and operator.

Or, put another way, how do you expedite a hotel management

agreement negotiation, while maintaining stamina to win impor-

tant economic and business points? The timing, direction and

focus of the process can be critical.

Ten Tips for negotiating hotel

management agreements:

1 Select your team and get access to a virtual data base of

market terms. You should identify the members of your

group who will have the authority to make decisions and

will be dedicated to the process. Just as importantly, you

need to seek the outside advisors — lawyers and con-

sultants — that can bring you the expertise and sense of

market terms that you don't have in your organization.

Our business and legal experience from more than 2,700

hotel management agreements and franchise agree-

ments provides the largest virtual database of hotel

management and franchise agreement deal terms in the

world.

2 Identify and prioritize the issues. There are at least 50

business issues that are tier-1 or tier-2 issues that need to

be raised and negotiated in a term sheet or LOI. (See The

The HMA & Franchise Agreement Handbook

HMA PRO™ Checklist, page 18) While term sheets and

LOIs are usually nonbinding, the failure to raise these

major issues at this stage will subject you to angry claims

that you are retrading if you want to raise them later. It

will certainly be harder to accomplish them later — if

you can at all — and will delay your process.

3 Control your own draft of the hotel management

agreement. Get the operator to provide you with a

Microsoft Word copy of the form of HMA they propose

to use. The operator may want to control the document

revisions, but that's not realistic in an age of long

distances and universal word processing. We can often

conform their HMA to the agreed-upon terms faster and

better than they can. In any event, we need it for the

process as described below.

4 Shaping the form HMA to meet your needs. We don't

mind starting with the operator's form HMA. That is

generally the accepted custom of the industry. However,

after working with you to identify the most important

business and legal points, we revise the operator's form

agreement to meet your needs, using redlining software

to track changes in each revised version of the document.

Usually, we will suggest the exact language to be used.

Sometimes, we will just highlight issues or options for

discussion.

5 Making sure we are all on the same page. Based on our

earlier discussions about your priorities and goal, we

then circulate a marked-up draft of the operator's form

HMA showing all of our proposed changes. This draft

only goes to you for your review, followed by a

conference call (or, where we and the owner are local, a

meeting) to discuss the agreement and any necessary

revisions. We review the document with you, page by

page, to get your input and approval for what we have

suggested. Most of the changes will be obvious as to

their purpose and effect. Some will not be, and we will

discuss these so we all agree to all proposed changes.

The HMA & Franchise Agreement Handbook

6 Revise and confirm. After our joint review of the

document, we make revisions to reflect your decisions.

If changes are minor, it may not be necessary to

recirculate to our team prior to sending to the operator.

If there are major changes or there is a desire to see the

revised language, we may recirculate to gain final

approval before sending the document to the operator.

7 Send the revised draft to the operator. The next step is

to send the proposed changes to the operator in the form

of the marked up draft we have already cleared with our

client. We jointly want to press the operator for a fast

turnaround with its own indication of what changes the

operator can accept or proposed changes to our changes.

If at all possible, it is very much to your advantage to

keep control of the drafts — our draft should be treated

as the new basis for negotiations. If not, we can make it

work, but the process is more laborious and time

consuming.

8 Set the all hands meeting. The goal is to get the

operator's markup or written response to our proposals,

commit to agreements on as much as possible

beforehand, and then to arrange a "meet until the deal is

done" meeting. Virtual meetings have overwhelmingly

replaced face-to-face meetings, except in unusually

complicated matters. These meetings usually take

several hours of focused discussion, perhaps requiring

the better part of one or two working days. The biggest

problem for you will be convincing the operator to make

someone available for the entire time necessary. Other-

wise, there can be a delay of days or weeks until the

follow up meeting is scheduled and the negotiations can

be completed.

9 Location of the all hands meeting. The availability of

representatives with decision-making ability will

probably drive this location, and you should be prepared

to travel to meet the operator on their turf, if it means

they will have the necessary people available. In some

cases, the distances between the operator's and owners'

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representatives may be so great that a virtual meeting

may be the only way of expediting the review. Many

owners and operators are more reluctant to travel as

video-conferencing has become a preferred alternative;

however, for intense negotiation, an in-person meeting

is ideal.

10 Exchange and finalize. After the all hands meeting, we

will circulate revised drafts of the HMA reflecting the

decisions. There may be a very small handful of "final

issues" to be resolved that we hold to the very end before

we give them up or trade them off. But there will be an

exchange of documents reflecting the final decisions that

should lead to an expedited signing of the HMA. If

something goes awry, we will do another meet-until-we-

sign meeting.

CHAPTER 2

WHAT YOU NEED IN

YOUR HOTEL

MANAGEMENT

AGREEMENT

The HMA & Franchise Agreement Handbook

What to do before you start

negotiating your brand HMA

Five tips for a successful relationship with

your operator and a good HMA

n order to consummate any substantial business transaction,

there are inevitably some challenges that must be overcome.

Hotel management agreements are no exception: in part because

of their complexity, and in part because hotel management

agreements typically transfer effective control over valuable

assets for decades, and their terms can easily enhance — or

diminish — the value of hotel by a staggering amount.

We have often seen hotel values depressed by 50 percent or more

from what the hotel would have been worth without the

encumbrance of an onerous, long-term management agreement.

The Global Hospitality Group® at Jeffer Mangels Butler &

Mitchell LLP has compiled a comprehensive list of many mile-

stones that mark the road to successful negotiation of a hotel

management agreement. As in all journeys with high stakes,

advance preparation — including mapping out the most advanta-

geous route and hiring guides that know the terrain — is critical

to success. In this instance, it's needed before you ever get to the

negotiating table.

This is especially true for those new to the hospitality industry.

Many sophisticated developers and investors have identified the

rich potential that hotels offer — particularly in hotel mixed-use

projects — and they regularly bring new vitality to the

marketplace. While not new to real estate development, these

players are new to the norms, customs, practices and business

considerations of hotels. The intertwining of single-purpose real

estate with an operating hotel business presents unique issues and

opportunities — opportunities that the uninitiated leave on the

table, simply because they were none the wiser. Developers and

owners new to the hotel arena can avoid an expensive and painful

learning curve by retaining experienced advisors that know the

value of each component in the management agreement from

both sides.

The HMA & Franchise Agreement Handbook

Here are our top five pre-negotiation milestones for helping

owners achieve success and strike a fair deal on a hotel

management agreement:

1. Get the right brand for your project

Every project is unique, and all appropriate brands, identities and

market position should be considered — along with the

appropriate operators who will enhance project value. The right

operator to optimize value may not be the branded management

company that puts its name on your hotel. It is important to note

that the continuing development of brand concepts can add great

value to a project, both from "brands" that are promoted by

traditional hotel companies and new players which many pundits

fail to recognize for the value they can bring.

Selecting the best brand and operator requires a careful business

and legal analysis of the owner's needs, goals and resources —

particularly for a hotel mixed-use project where the hotel is often

the spark plug for the synergies of mixing uses. That's why we

like to bring our knowledge and resources to the owner's team

before the brand and operator candidates are even identified. We

can help identify the right players, scope out areas of strength and

weakness, and help our owner or developer client articulate and

prioritize goals to be accomplished in an HMA PRO™ process.

This kind of preparation can enable an owner to better gauge the

strengths and weaknesses of each potential brand, find the

optimal terms that the brands and operators are willing to extend,

and facilitate an informed decision and a smooth negotiation with

reasonable expectations on all sides.

2. Look for common perspectives

Sometimes, we are brought in late on the hotel management

agreement process — after the initial candidate consideration and

selection and perhaps into the Letter of Intent, or LOI, stage.

When this happens, we too often find that the table has not been

properly set. As deal terms and drafts begin to exchange, it can

appear that owners and operators are contemplating two different

projects ... because they are! The owner comes to the negotiating

table with one set of financial projections and program elements,

while the operator has its own. Set side by side, they would seem

to describe different projects — different concepts for the hotel's

The HMA & Franchise Agreement Handbook

target market segment and customers, its sources of revenues,

costs of construction and maintenance, integration of the hotel

with other project elements, and even the project's financial

viability.

If the owner believes the project is highly profitable and the

operator does not, the natural (and reasonable) result will be for

the operator to try to protect itself by demanding higher fees and

incentives, which will create a chasm between the owner and the

operator. If the operator believes that the project requires

substantial amenities and the owner does not — or if they cannot

agree on how hotel mixed-use project elements will be integrated

— it is more likely that the owner and the operator will be unable

to agree on key issues, such as the total cost of the project and

owner's required investment. (Remember that selecting the right

operator, based on objective data, makes a meeting of the minds

more probable.) The operator and owner must agree as to what

the project will look like and what will drive its success.

3. Address the challenges early

During negotiations, it may often make sense to defer certain

tough issues for later resolution so that all the areas where

agreement can be reached are understood, and the importance of

the areas that require compromise are clear. However, there

comes a time when the parties have to discuss the elephant in the

room that they have been ignoring. Talking about the elephant

sooner, and more directly, may allow both sides to create global

resolutions. And of course there may be situations where owners

and operators will not fully resolve certain issues, either

intentionally or unintentionally. While it's true that parties cannot

be expected to resolve each and every issue that might come up

during the term of a management agreement — that would

require the ability to predict the future — failing to address

known issues can be an expensive way to reach "agreement"

because it leaves potentially messy disputes for the future.

4. Know what's "market" and how it fits your goals

While both owners and operators usually seek to negotiate

agreements with market terms, every hotel property is unique.

And, there is really no simple metric or checklist of market terms.

There are ranges of what are considered market terms for

The HMA & Franchise Agreement Handbook

particular types of properties or projects and specific brands or

operators. For example, the terms for branding or operating a

2,000-room convention hotel are quite different than a 200-room

full service urban hotel or a 120-room extended stay property.

And market is also defined by the competition for a particular set

of brands or operators, which will vary depending on how

desirable a specific hotel project is, and how important that

location or property may be for the strategic and business needs

of a brand or operator (e.g. to fill in a critical hole in its distribution

system, maintain a presence in a key market, etc.). And,

ultimately, a market deal is the deal you make.

These factors make it very valuable for an owner to have an

experienced team who may know better what market is than the

brand or operator — and will at least know what the operator has

done in six recent deals and, just as importantly, what their three

closest competitors are likely to offer on a sticky economic or

business point. There are also a lot of trade-offs that make up a

market package. In other words, it is a little like going to a

smorgasbord buffet with $100 worth of tickets, and you have to

know the price of each item if you are going to get the meal you

want. If you spend all your money on the caviar and dessert, you

won't have any left for the main dish or the beverage. All items on

the buffet are not of equal cost or value.

So, while there are some commonly accepted ranges for business

and legal parameters for hotel management agreements, an

owner needs to recognize that they can be broad, and owners may

need to be flexible to accomplish their goals in a particular

situation.

5. Bring the right team to the table

Negotiations don't occur between companies; they transpire

between the people representing those companies — and it is

essential to have a team with the comprehensive set of experience

and skills to negotiate and document a successful hotel

management agreement. Hotel management companies usually

have a strong bench of experienced lawyers, dealmakers, financial

experts and others who understand fully their goals and needs,

because they are actually in the business of sourcing and

negotiating management contracts and franchise agreements.

The HMA & Franchise Agreement Handbook

Owners typically have not experienced the frequency or volume

of hotel management agreement negotiations that operators have,

and should retain experienced lawyers and advisors in order to

level the playing field. But more than just arming oneself in

negotiations, retaining experienced professionals will make the

negotiations more productive for both sides.

Owners will want to draw on professionals who have had direct

experience with the operator, as well as broad-based experience

in the industry. A hotel lawyer and consultant who knows what

a particular operator has done in other deals, as well as what that

operator's competition has done (and is likely to do again) is able

to bring great value to the owner's side of the discussions.

Finally, it is essential that owners understand the critical

importance of their own active participation in the hotel manage-

ment agreement negotiations. While it may be convenient to leave

the discussions to the professionals (and certainly portions of the

discussions can and should be handled by attorneys or consul-

tants), a lot of issues will ultimately be won or lost by the passion

and conviction of the owner. "I am just not going to do that," goes

a long way toward convincing the operator that a specific issue is

too important to be compromised.

That is one of the reasons that we spend so much time with

owners — particularly first time hotel owners and developers —

to help them understand the real practical significance of manage-

ment agreement provisions. It isn't rocket science, but it is

understanding the business implications of hotel management

agreement terms on the owner's goals and plans, and seeing what

should be accomplishable that makes a difference.

Preparation to successfully negotiate a hotel management

agreement starts early. It starts before you ever identify potential

candidates and way before you ever start talking terms. The

roadmap you establish — along with the practical experience of

the professional team members you line up to structure and guide

the process — can make a substantial difference in the outcome

and long-term success of your entire project.

The HMA & Franchise Agreement Handbook

Hotel management agreement

performance standards

and why they matter

erformance standards matter because hotel owners and hotel

operators do not always share the same goals. Most hotel

owners want their hotels to be profitable, or at least run with a

focus on optimizing long-term value. Others may want their

hotels to operate at a specified level of luxury in order to provide

the right "amenity" essential to other components in a hotel

mixed-use project, or adjoining property. But even where luxury

is important, owners always desire to accomplish luxury in a

prudent and businesslike way.

Generally, hotel operators, and brand operators in particular,

want to increase the number of hotels under management or

franchise (their "distribution system"), burnish or enhance the

brand image and its public recognition, bring hotels to a

minimum level of standardization, and increase profits by

making hotel owners absorb more of the hotel operator's

corporate expenses, and extending their brands to other products

(like time share, or residential products).

If individual hotels are not profitable, or are not operated at the

desired level of service, the operator's other goals are not

necessarily impacted. In addition, hotel operators typically

receive a big portion of their compensation as a percentage of

gross revenues off the top before operating expenses, debt service

or any return to the owner. Their reservation and marketing

systems, and other centralized services are also typically

supported off the top by payments from the hotel in

reimbursements or as percentages of gross revenues, so these

factors incentivize growth of the system (with attendant recruit-

ing, training and staffing challenges and costs) and increasing

gross revenues whether any profit is falling to the bottom line.

The difference between the owner's goals and the operator's goals

doesn't reflect a "right or wrong" situation, or a value judgment; it

does mean, though, that owners and operators need to work

together to ensure that their needs and goals are adequately

The HMA & Franchise Agreement Handbook

represented, and that the management agreement reflects a

reasonable compromise.

One of the popular misconceptions of performance standards is

that the purpose of the standard is to give an owner a "free" right

to terminate an HMA without being required to pay a termination

fee. That is not the purpose of a performance standard (although

it can be the result, if the operator ignores its obligations). Owners

only terminate management agreements as a last resort; the

difficulty in finding good managers and the cost of changing

managers or rebranding a property, among other things, means

an owner is more likely to stay with an underperforming

manager, and we regularly advise our clients to find ways to

maximize the commitment and performance of their managers

instead of terminating prematurely. Instead, a performance

standard, if negotiated carefully, establishes a meaningful

measure of the operator's performance and aligns the interests of

owners and operators.

But the power to terminate a hotel management agreement does

offer an owner what may prove to be a necessary tool to gain the

attention of the operator and some meaningful compliance, or

readjust the terms of the HMA. In this way, the performance

provisions can help ensure that the HMA remains in place, be-

cause the owner and operator know what to expect from each

other and will have incentives to understand their respective

obligations to one another and to avoid problems in the future.

What does an operator want?

Put simply, the hotel operator does not want to be penalized for

events and causes that are beyond its control. For this reason, a

hotel operator will not want to be responsible for the profitability

of the hotel, economic conditions that reduce the hotel's revenues

or profits, labor disturbances which interfere with operations, or

unanticipated events, like the cancellation of a large convention.

Because of this, most operators will see the ideal performance

standard as one with as few teeth in it as possible. Remember, the

profitability of the operator depends on it having as many long-

term HMAs in place as possible. The longer the deal, the more the

operator will receive in the form of management fees, licensing

fees, and the like and the higher the market will value the

The HMA & Franchise Agreement Handbook

operator. Therefore, it is in their interest to draft performance

standards in such a way that it will be very difficult to ever

terminate the HMA for failure of performance.

What does the owner want?

Owners are interested in many things. It may be prestige, amenity

value for other parts of a project or related properties, or an

efficient and well-run place for tourists or business people to stay.

These are typically all the things that brand hotel development

staff (the salesmen for the brand) promise over rounds of golf and

nice dinners when courting the owner for the management

contract. But if these perceived promises are not engraved into the

terms of the hotel management agreement — including the

performance standards — they will be difficult to enforce later on.

So if prudent and efficient operations, building long-term value

and profitability are important to enable the owner to pay lenders,

investors and itself, they'd better be properly reflected in the

documentation.

These concerns lead the owner to seek performance standards

which provide incentive for the operator to operate the hotel at

the required level of standards, to maximize profits in accordance

with the performance thresholds, and to impose those tests

consistently, whether or not the operator can control the results.

Three guideposts for negotiating

HMA performance standards

Here are three suggestions to follow in negotiating effective

performance standards.

Know thyself. Recognize how important the HMA will be to the

value of the hotel and treat it accordingly. Carefully define all of

the important measures of success for your project, whether it be

through profit margins, minimum revenue thresholds, or achiev-

ing specified levels of service or recognition (such as Mobil star or

AAA diamond ratings). Unless you can explain your needs, you

won't achieve your goals.

Be realistic. Understand your strengths and be aware of the

operator's needs. Seeking unrealistic goals is likely to prevent you

The HMA & Franchise Agreement Handbook

from gaining the agreement you want, and won't make your

objectives any easier to achieve.

Get help. You need to understand the different ways you can

achieve your needs. You need to know what operators have

agreed to in the past and what they might agree to now. You need

a legal and advisory team that negotiates management

agreements every day, and has experience with all the brands and

boutiques, both as to market terms at a given time, as well as

alternate solutions to solve both parties' needs or find reasonable

compromises.

The HMA & Franchise Agreement Handbook

Hotel management agreement

performance standards — the

operator's take

hat does a typical operator performance clause look like?

Operators may propose an HMA without any

performance standard. That would be in their interest, because a

performance standard can only be used to their disadvantage —

to reduce their income, subordinate their fees, or possibly

terminate the management contract. And of course, the right to

terminate is the right to re-negotiate the agreement as well. So

failure of a performance standard does not mean you have to

terminate the operator, but it might be used as the basis to re-

negotiate the allocation of financial and other risks.

The typical performance standard clause proposed by a branded

hotel operator often looks something like this:

In addition to the other rights of termination in this

Agreement, the Owner shall have the right to terminate

this Agreement if, for any two consecutive Fiscal Years

beginning after the completion of the third (3rd) Full

Fiscal Year, both (a) the Annualized RevPAR for the

Hotel for such Fiscal Year is less than 80% of the average

Annualized RevPAR for the Competitive Set for such

Fiscal Year (the "RevPAR Test"), and (b) the Gross

Operating Profit of the Hotel is less than 80% of the Gross

Operating Profit of the Hotel as set forth in the Annual

Budget for such Fiscal Year (the "GOP Test") (the

RevPAR Test and the GOP Test are collectively referred

to as the "Performance Standard").

This provision is fairly short, but it contains a number of moving

parts, and we need to discuss some of the key components.

What is RevPAR?

RevPAR is the acronym for "Revenue Per Available Room."

RevPAR is calculated by dividing the gross revenues for a hotel

for a period of time by the total number of available room nights

over the same period. The resulting number will tell you how

The HMA & Franchise Agreement Handbook

much money you are generating from each room in your hotel for

a particular period. It is a way of combining the results of two

other key factors — average daily rate or ADR and Occupancy.

The ADR is included in the revenue component of RevPAR, and

the occupancy is encompassed in the available room night

component.

What is the competitive set?

The competitive set is a group of hotels that are similar to your

hotel. For example, a 100-room select-service hotel might be

compared to a nearby Courtyard by Marriott, but not the Ritz-

Carlton next door, which would be excluded. Picking the

competitive set is a critical issue and something of an art. The data

for the competitive set is provided by independent data sources,

like Smith Travel Research (STR), which usually require a

minimum of five different hotels and a variety of underlying

brands in the set to ensure confidentiality and anonymity of hotel

data participants.

What is the budget test?

The budget test requires that the Hotel achieves a minimum

percentage (most often less than 100 percent) of the profit that the

operator anticipated in its budget for a particular year. This

standard raises a very important issue for owners, since operators

prepare the budgets for the hotel and therefore have the ability to

propose a budget that is easier to achieve. While owners typically

have budget approval rights (or at least they should), operators

are in a much better position to forecast the potential profitability

of the hotel. Even more importantly, the operator, by virtue of its

management of the hotel, is in a position to manipulate the

operations of the hotel to achieve the necessary level of

performance. For example, an operator might choose to push

certain expenses into a following year to meet the operating test

or accelerate certain income.

Why is it measured over two consecutive years?

Operators prefer to structure a performance test so that the

operator only fails the test if it doesn't meet the minimum gross

operating profit (GOP) level in two consecutive years. This helps

protect operators, since the operator isn't in danger of being

The HMA & Franchise Agreement Handbook

terminated if it suffers one bad year out of a series of good years.

However, it also emphasizes one of the concerns that an owner

should have about the budget test — since it takes two years of

failure to trigger the owner's right to terminate, the operator can,

in the second year of a down cycle, revise its projections to make

it less likely that they will fail, and also make it easier to maneuver

the financial performance of the property and avoid termination.

It also means that a hotel could perform poorly for several years,

which reduces the value of the hotel and the ability to finance it.

Is this two tests, or one?

The performance test usually proposed by an operator is designed

so that the operator has to fail each of the tests in both years of the

test period to be subject to termination — in other words, the

operator might not achieve the budgeted profitability, but if it

operates on par (or, in the example above, 80% of par) with its

competitors, that year doesn't count as having failed the test. An

operator wants this because it doesn't want to be penalized if the

hotel doesn't make its predicted profits, but operates at least as

well as its competitors; conversely, a hotel operator would not

want to be subject to termination if it achieves anticipated

profitability, even if other hotels in the area operate more

profitably.

"Cures" and other parts of the performance test

There are often additional components or matters that relate to

the operator's performance test. For example, an operator

performance provision will often provide that the operator can

avoid termination if it "cures" the performance failure by paying

the owner the difference between the actual profits and budgeted

profits for the year. Should the operator have any cures if the

performance standard is to be meaningful? If so, how many? Must

the cure be made for the first year of performance test failure? If

not, does the two consecutive year test completely reset or just

need one more failing year? What is the right measure of a "cure"

payment? Does the missed profit really cover all the damage?

Certainly not!

Well, the details of a "cure provision" of a performance test are

complex and are not treated here except to alert you to its

importance. Additionally, don't forget that the operator will

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typically seek to be excused from the performance tests for any

period of time that involves an event that qualifies as a "force

majeure." There are typically also "passes" from the test or

"lockouts" from exercising any rights under it for an initial

stabilization or lockout period that may run from 12 months to

seven years, or longer, or during periods when the property is

being upgraded.

And any breach of the HMA by owner claimed by the operator —

such as failure to fund a big capital improvement program — may

also excuse the operator from a performance test.

What should I consider when negotiating the

performance test?

Every little thing matters. The test looks simple, but every part of it

is meaningful. For example, constructing the competitive set

alone raises many issues:

 Are there really five hotels in your market that

compete directly with your hotel? Many times it is

difficult to find those hotels, and you have to

consider adding hotels that are in different classes or

different locations.

 What is the right percentage for the test? If the

average RevPAR for the hotels in the competitive set

is lower than your hotel, a target RevPAR of 90

percent of your hotel's projected RevPAR may be too

low, making the test less than meaningful. A new

hotel should significantly outperform an older set of

hotels. Maybe your hotel should be at 120 percent of

the competitive set.

 What happens when new hotels come into the

market area, or existing hotels in the competitive set

close, or when hotels are rebranded? Should that

change the RevPAR test?

These are only a few of the most obvious issues, and given all the

other issues in a complex hotel management agreement, a hotel

The HMA & Franchise Agreement Handbook

owner needs expert assistance to ensure not only that the perfor-

mance test itself is meaningful, but also that it works seamlessly

with the remainder of the agreement and all of the parties' goals.

The HMA & Franchise Agreement Handbook

Hotel management agreement

performance standards —

the Owner's Return test

n the last section, we looked at a typical hotel operator perfor-

mance clause and how it protected the operator interests. For

the owner to have a termination right under such a clause, the

hotel operator must fail both prongs of a two-prong test: the

RevPAR test, which compares the RevPAR results of the subject

hotel to those of a competitive set of hotels, and the budget test,

which requires the operator to achieve profitability based on the

operator's projections in a budget. We also pointed out some of

the challenges posed by that test.

In this section, we will look at a performance test that takes better

care of the owner's concerns and which raises some issues with

operators.

What is the interest that owners want to

protect with a performance test?

The bottom line is that owners want to receive an adequate return

on their hotel investment. Owners need the return because they

are expected to pay debt service, pay property taxes and property

insurance, provide working capital, fund capital expenditures

and provide a return to their investors. If they don't get that

return, owners should have certain rights. There are a variety of

tests, but we believe the most effective, meaningful and fair test is

an Owner's Return performance test.

The concept of an Owner's Return performance clause is rather

simple: Unless the operator can manage the hotel to generate

sufficient profit and distributable cash to provide the owner with

a specified return on investment, the performance clause has not

been satisfied, and certain consequences follow.

Normally, we use the Owner's Return test for two purposes:

1 Create a viable investment. Identifying the Owner's

Return clarifies the expectations of the owner and the

operator, and is an essential part of the "bargain"

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between the owner and the operator. Ultimately, if the

operator cannot fulfill its part of the bargain, the

performance standard gives a hotel owner the option to

terminate the hotel operator when the test is failed.

Sometimes the ability to terminate an operator can be the

only effective way to truly get the operator's attention

and redirection to take care of the owner's concerns.

2 Hurdle for incentive compensation and subordination

of fees. Independent of any termination right that may

attach, no incentive fees should be payable to the

operator in any year unless the performance test has

been satisfied. While uncommon, in some cases, a

portion of the operator's base fee — say anything over

1.5 percent of gross revenues, or perhaps anything in

excess of half of the base fees — may similarly be

conditioned on and subordinated to payment of the

Owner's Return for the given year.

How do I measure Owner's Return?

The required Owner's Return is determined by this formula,

calculated annually:

Owner's

Return

Total investment

in the hotel

Agreed upon

investment return

For example, if the total investment in a hotel were $25 million,

and the agreed upon investment return were 12 percent, the

Owner's Return would be determined as follows:

Owner's

Return

$25 million

12%

Owner's

Return

$3 million

Total investment in the hotel

The first key to measuring the Owner's Return is to calculate the

owner's total initial investment in the property, including all costs

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associated with the investment, both debt and equity, and all hard

and soft costs.

That initial investment should be increased each year by all of the

owner's additional investments. We typically provide for the

addition of three major items to the calculation of owner's

investment in the hotel:

1 Contribution to FF&E fund, when contribution is

made. Virtually all management agreements (and

franchise agreements and loan agreements) require an

owner to set aside a reserve to pay for regular

replacements of furniture, fixtures and equipment

(FF&E). These reserves reduce the cash the owner might

otherwise retain from the operation of the hotel, and

represent an additional investment by the owner.

2 Capital expenditures not paid from the FF&E fund. As

a hotel ages, the FF&E fund may not be adequate for the

maintenance of the hotel. Major upgrades to its soft

goods, replacements of furniture, fixtures, and

equipment, or other capital projects will usually be paid

out of hotel revenues (that would otherwise have gone

to the owner) or from additional investment by the

owner. Unless these amounts came from the FF&E fund,

they also represent additional investment by the owner.

3 Any additional working capital contributed to the

hotel, not otherwise included in the preceding items.

From time to time, working capital may be required for

various reasons, such as seasonal business needs or

operating deficits from disasters or business cycles.

Investment return

After the owner's total investment in the property is calculated for

a given year, the Owner's Return is derived by applying a

percentage to that which must be paid out of profits to satisfy the

test.

A common goal of owners is to achieve something on the order of

a 12 percent annual return on their total investment in the hotel.

Over the past 20 years we have regularly obtained a reasonable

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Owner's Return provision from almost every major brand — at

least when they really want to manage the particular hotel.

Their willingness to give this kind of performance test is a much

truer reflection of their enthusiasm for a project and their belief in

its success than all the laudatory fluff shared in the process of

selling the owner on hiring the operator.

What do operators think of this test?

Operators understand the importance of a return to the owner,

but often object to this test, particularly when it could allow an

owner to terminate a management agreement. As we have

pointed out before, hotel operators do not want to guarantee

performance, and limit the tests of performance to those things

that are within their control. Since operators cannot control the net

income from the property, the owner's acquisition costs or

continuing investments in the hotel, some operators will argue

that owner termination for failure of this test is problematic.

On the other hand, if an operator can't manage a hotel to provide

the owner with a reasonable rate of return, the owner should at

least have the option to change things up.

The HMA & Franchise Agreement Handbook

Five keys for good HMA budget

provisions

he budget provisions in the HMA provide the means by

which the owner achieves efficiency and profitability, and

the operator achieves brand integrity. While both are equally

critical to the success of the hotel, operators are often able to drive

the budgeting process to their advantage.

Importance of budgets

It is difficult to overstate the importance of a meaningful

budgeting process for a hotel. Ultimately, the budget represents

the implementation of the owner and operator's vision for the

hotel. It is the means by which the owner and operator achieve

the qualitative goals we associate with the brand or style of the

hotel, and the quantitative goals of achieving a well-run, efficient

and profitable business. Moreover, it is often the means by which

we judge the performance of the operator.

The approved budget is also key to many other provisions in the

HMA. Often, the inclusion of a line item expense in a budget will

constitute the owner's approval of that expense without further

inquiry. For this reason, owners consider the budget process

seriously and recognize that it will have far-reaching impact on

the success of the property. Properly drafted, the budget process

created by the HMA provisions can provide the owner its most

significant ability to affect the operations, profitability and success

of the hotel.

Challenges

Owners face a significant challenge in the budgeting process.

Simply stated, the operator has the upper hand for a variety of

reasons. Unlike owners, operators create budgets all the time.

Operators have entire departments of staff dedicated to budgets

and have much greater experience with budgeting than owners

do. This experience and capacity gap increases each year.

Operators almost always dictate the form of the budget, giving

them a benefit in presentation (and knowing in which three line-

items an expense is buried). Moreover, operators have access to

much more information than do owners, both as to the property

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at issue and all of the operators' other properties. For these and

other reasons, operators almost always have a big "home field

advantage" when it comes to creating and evaluating budgets.

Owners face another challenge in that while operators spend

many months preparing a proposed budget, owners have only a

short window of time at the end of the year in which to evaluate

and critique budgets. Some operators have told us that budgeting

is, in fact, a year-round process. Given the reality of Thanksgiving,

Christmas and the New Year's holidays, owners have only four to

five weeks to evaluate and respond to the budget that operators

have been preparing for months.

Five key elements to a successful budget provision

Given these facts, there are five key pieces to crafting a good

budget provision in an HMA that can add great value to the hotel

and save a lot of grief when times get tough.

1. Time. The proposed budget must be delivered in time for

the owner and its advisors to evaluate it carefully and

thoughtfully respond — at least 60 days before the

beginning of the fiscal year, typically November 1. Doing

so will allow time for the necessary review, comments,

redrafting and review that makes the budget process

meaningful. If possible, the operator should provide

preliminary budgets even earlier.

2. Scope of review. Some operators will attempt to limit the

scope of the owner's review by stating that certain

estimates, such as anticipated room rates or expenses

necessary to meet brand standards, are not subject to

owner's objection. This is wrong! The owner should have

the ability to question everything in the budget. It doesn't

mean the owner will always prevail, but the owner should

have a say.

3. Owner's approval; resolution of budget disputes.

Owner's approval rights of the budget must be similarly

meaningful. It is not adequate to provide that the operator

shall consider the owner's comments in good faith, and

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then shall be entitled to make the final decision in its sole

discretion or words to that effect.

 Use of an independent expert. If a dispute

cannot be resolved between the parties, it

should be handed to an independent

expert who reviews the issues from not

only the operator's side but also from the

owner's side. We also like to provide a

standard (other than just "brand stand-

ards") that governs how the expert will

decide the dispute.

 Baseball arbitration. Often, it makes sense

to be explicit and consider "baseball"

arbitration as an alternative to "traditional"

arbitration for budget disputes. In baseball

arbitration, the arbitrator must adopt the

position of either party, but cannot custom

design his own random solution. Baseball

arbitration tends to force each of the parties

to be more reasonable (i.e. to narrow the

gap) so that they don't lose everything they

want. And it means that at least one party's

vision will be implemented, instead of a

cut-and-pasted collage of two different

approaches, or leaving the decision in the

hands of a party that has no stake in the

outcome.

 CapEx should be sole approval of the

owner. There is one exception to an

arbitrated resolution of budget disputes —

capital expenditures. Capital expenditures

beyond the regular, agreed-upon contribu-

tions to an FF&E reserve should be within

the owner's sole control.

 What happens if there's no agreed

budget? Hand-in-hand with the approval

and dispute resolution process is a means

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of operating the hotel pending resolution

of a budget dispute. Most agreements

provide that when the parties cannot agree

on the budget (or any parts of it) the

operator will operate in accordance with

the parts of the budget that are agreed

upon; for the other parts in dispute, the

operator will operate under the prior year's

budget with some kind of adjustments.

While this is generally workable, adjust-

ments should be considered where a prior

year included one or more unusual

transactions or events. Owners should also

consider using the prior year's actual

expenditures instead of the prior year's

budget, since actual experience can be a

better indication of future requirements.

4. Budget format. While it should go without saying, budgets

must be provided in adequate format and detail to provide

real information about the operator's plans. Budgets

should be detailed enough to include not only the line

items, but clear narrative explanations of the assumptions

underlying those line items. It is also essential that the

budget process be integrated, so that operating, capital and

marketing expenses are presented as a unified whole.

Budgets should also be zero-based, rather than just

increased (or decreased) some increment from the prior

year. The underlying assumptions and rationales of the

budget need to be rethought and reanalyzed, so that

owners are not presented with the repetition of prior years'

mistakes and do not miss the changes in markets or

technologies that move so quickly.

Finally, an essential part of the budget should be a

narrative explanation of the assumptions on which the

proposed budget is based. A manager should be able to

provide the rationale for its estimates, which will allow the

owner to understand better whether the manager is "in

sync" with the owner.

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5. Variances and amendments. Most operators argue that

budgets are a planning device but cannot be relied upon,

and they should be authorized to stray from the budget.

This results in a meaningless budget. We believe that the

operator should be contractually required to adhere to the

budget except for permitted variances which are carefully

defined in the budget provision of the HMA.

Consequently, while minor variances can be tolerated, some basic

guidelines should be followed such as those below.

What goes up also goes down. Operators often provide that

expenses can increase when occupancy increases. That may be

true, but operators should be held to the opposite as well. When

occupancy drops, operators should work effectively to reduce

expenses and maintain profit margins.

Budget line items are not fungible. Operators sometimes argue

that savings in one part of a budget should allow for overruns in

others. This merely makes the budget process ineffective. Each

part of the budget should stand on its own.

Back to the future. Changes to the budget should not be imposed

by the operator alone. If circumstances change, the operator

should submit a new budget for review and approval on the same

basis as the original budget, along with an explanation of what

went awry and what is being done in response.

Don't be a stranger. The budget should be considered along with

the operating results for each monthly reporting period, and the

operator should be required to report regularly on its budget

compliance, the causes of variations, and how they are being

addressed.

Conclusion

Hotel owners who fully participate in the budgeting process can

positively affect the operations and profitability of the hotel. The

budgeting process can be time-consuming. But isn't it worth

taking the time once a year, however inconvenient, to protect your

investment? The budgeting process can also be contentious. But

isn't it worth it to work through disagreements to find ways —

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one line at a time — to leverage your investment into greater

profitability? And wouldn't it be great if you and your operator

understood and respected each other's needs and were aligned in

your commitment to owning and operating a great hotel?

The HMA & Franchise Agreement Handbook

Indemnification provisions

ndemnification is usually a payment (or sometimes a repair or

restoration) made to restore a party to its condition or situation

prior to some event. In the context of HMAs, it usually means that

one party, typically the owner, will protect another party,

typically the manager, from a monetary claim related to the hotel

or its operations.

Indemnification provisions in HMAs:

What's the fuss all about?

A simplified indemnification provision in an HMA might look

like this:

Owner shall defend, indemnify and hold Operator

harmless from and against any and all liabilities, fines,

suits, claims, obligations, damages, penalties, demands,

actions, costs and expenses of any kind (including legal

fees) (collectively, "Claims") arising out of (i) any action

or omission or course of action on the part of Operator in

its performance under this Agreement; (ii) any obligation

incurred by Operator, whether alone or together with

Owner or by Owner alone, in connection with the Hotel;

and (iii) Owner's breach of this Agreement; provided that

this indemnity shall not apply to any Claims resulting

from the willful misconduct, gross negligence or bad

faith of Operator.

Why is an indemnification provision needed

in an HMA?

Indemnification is usually included to deal with third party

claims such as those brought by guests (for lost property or

injury), governments (e.g., liquor license or fire & safety

violations), or employees (sexual harassment or wrongful

termination). It identifies when and how the owner will be

responsible for a claim against the operator, and when the opera-

tor will be responsible for a claim against the owner.

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What does it do that isn't in the rest of the hotel

management agreement?

It may alter or reverse the "normal" allocation of financial

responsibility for third party claims.

For example, in about 80 to 90 percent of current hotel

management agreements, the operator is technically and legally

the "employer" for the hotel's employees — the hotel staff and

management are on the official payroll of the operator or one of

its subsidiaries, and the operator recruits, hires, fires, trains and

supervises the employees.

If an employee filed a claim against the operator for

discrimination or sexual harassment, the employer would nor-

mally be responsible for such claims. After all, it is the employer.

But a common indemnification provision might say that the

owner has to indemnify the operator against any employee

claims. Many owners find this extraordinary, inasmuch as any

wrongful action would most likely be caused by the operator.

The theory of such a common indemnification provision by the

owner or the operator is that "the operator is not paid enough to

assume this kind of liability." The operator feels that it is just

acting as the employer as an accommodation to the owner, and

the owner should pay for all employment costs, benefits, and even

such legal claims.

Under the sample indemnification provision above, the owner

would probably be liable for any such employee claims against

the operator.

Why should the hotel owner care?

When the owner has to pay the first $5 million judgment for

employment discrimination or sexual harassment by the operator

— or has it deducted from the hotel's operating accounts — the

owner will care, and will appreciate the importance of the

indemnification issue (although it will be too late to change the

provision for the duration of the HMA).

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What do hotel operators want?

Operators generally want to avoid paying any costs incurred in

operating a hotel. They want to protect their base and incentive

fees from any offsets or reductions, and want to be shielded from

any claims incurred in the course of their operating the hotel for

the owner. Operators do not want to guarantee any kind of

performance or liability. They view the claims that are being

indemnified as a normal and ordinary cost of doing business —

claims that the owner would bear if it were operating the hotel

itself.

The limited exception that operators are generally willing to make

to their complete indemnification by owners, is for a claim that is

caused by the operator's own gross negligence, willful

misconduct or breach of the HMA. Operators are also generally

unwilling to allow "attribution" — where the acts of hotel

employees hired and supervised by the operator (which can

include the general manager and key, high-level supervisory

personnel) are "attributed" or charged against the operator.

In the operator's "perfect world," it has no liability for the

negligence of its employees, including the acts of a general man-

ager, unless the owner can show that the negligence was the result

of corporate gross negligence or willful misconduct of the

operator.

What do hotel owners want?

Hotel owners want operators to manage their property as

professionals and experts. They generally do not expect to pay for

damages or losses caused by someone else's negligence, breach of

contract or violation of law — much less gross negligence or

willful misconduct. In fact, hotel owners want to be indemnified

by the hotel operator if the operator causes losses for any of these

reasons.

What message is being given here?

The evolution of indemnification provisions mirrors the evolution

of hotel management agreements in general. Originally, most

hotel management agreements held operators accountable for all

their negligence and misconduct. But for many decades, by

industry custom and practice, most branded operators and

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independents today limit their responsibility to gross negligence,

willful misconduct and breach of contract. Operators, (including

both established brand operators and many

independents) — have reduced their obligations and their

liabilities, making management agreements more valuable to

them.

The current state of the industry concerning indemnification

provisions — like many other provisions of hotel management

agreements — sends a difficult message to owners. While

operators and owners should be aligned in their goals, this

provision highlights the differences and the tension between the

positions.

How can you resolve it?

There is no simple answer; each situation is unique. The indem-

nification provisions cannot be viewed in a vacuum. You need to

understand how these provisions relate to the entire agreement,

and address indemnification as part of the overall relationship

between owner and operator in the hotel management contract.

Unless you are handling hundreds of hotel management agree-

ments a year you will not know all the ins and outs and current

market trends. Not even professional or institutional hotel

investors should start the management agreement process (even

in negotiating the LOI or term sheet) without veteran hotel

advisory and legal counsel experienced in these agreements.

Putting it all in context...

Hotel management agreements (at least such contracts with the

branded hotel companies like Marriott, Hilton, Hyatt, IHG, and

the like) tend to be very long term, "no-cut" contracts. Entering

one of these arrangements is a little like turning complete control

of your asset over to someone on a 99-year lease, except the "rent,"

if any, depends on what is left over after the manager gets done

operating the hotel to its standards. But in addition to that, you are

responsible for all operating shortfalls and capital expenditures

that are not covered by available cash from hotel operations. The

terms of the hotel management contract are likely to govern the

relationship of hotel owner and operator for many decades and

are hard to change once cast.

The HMA & Franchise Agreement Handbook

SNDAs: Subordination agreements

affect the value, financeability and

collateral value of a hotel

or our purposes the following three terms are identical in

meaning and fully interchangeable in the context of hotel

operating agreements:

 Subordination Agreement

 Subordination, Non-Disturbance and Attornment

Agreement

 SNDA

Subordination agreements are frequently used with various types

of real property when someone other than the owner is occupying

or using the property secured by the lender's loan. So in the hotel

industry, this arrangement involves the hotel owner, the hotel

operator and the hotel lender. And because the lender's joint

agreement is required, typically the HMA will specify that these

three parties will execute an SNDA (as a free standing agreement)

prior to placing any lien on the hotel. The terms of the SNDA may

be specified in the HMA, set forth in an attached exhibit, or

required to conform to the requirements of the hotel operator or

hotel lender.

What are the three prongs of a typical SNDA?

An SNDA typically has three prongs, as follows:

Subordination (the "S" in SNDA). The hotel manager agrees to

subordinate its hotel management agreement and any other

interests in certain respects to the lender's lien. Most lenders insist

on having some kind of subordination from a hotel operator as a

condition to making a loan, and the inability of an owner to

compel the delivery of subordination in a form satisfactory to the

lender may jeopardize the financing.

Non-Disturbance (the "ND" in SNDA). The lender typically

agrees not to disturb the manager's enjoyment and control of the

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property, and not to attempt to terminate the hotel management

agreement executed by the owner/borrower or to remove the

manager if the lender becomes the hotel owner as a result of

foreclosure. While this makes sense as long as a loan is

performing, it can seriously diminish asset value and flexibility

after a loan default by the owner/borrower.

Attornment (the "A" in SNDA). The manager agrees to recognize

the lender, or its successor in interest, as the new owner having

the right to enforce the hotel management agreement after the

lender forecloses or acquires the hotel by deed in lieu of

foreclosure.

What does a subordination provision look like?

While the terms of an SNDA will undoubtedly depend upon the

operator's and lender's relative sophistication and bargaining

strength, a typical hotel management agreement is likely to have

something like the following provision:

Subordination. Owner shall ensure that all existing and

future Mortgagees and lessors provide Operator with

non-disturbance agreements in form and content rea-

sonably acceptable to Operator, which agreements shall

preclude the termination of this Agreement absent the

uncured breach of this Agreement by Operator, and shall

further preclude the conveyance or leasing of the Hotel

(whether on foreclosure, deed in lieu thereof or

otherwise) to any Person to which Owner could not

assign this Agreement without Operator's consent.

As an owner or lender, do you know

why the SNDA is so important?

As one critical part of a long-term hotel management agreement

that may govern the parties' rights and liabilities for decades, the

SNDA controls how each party's interests will be served or

thwarted. In other words, the SNDA will strongly affect the

owner's ability to finance or refinance the property, and possible

liability on loan default. Similarly, the SNDA will control vital

aspects of the lender's flexibility on loan default and in workouts,

receiverships, foreclosures, bankruptcies, or deeds in lieu. The

SNDA is also likely to have a dramatic impact on the value of the

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hotel, and how many bidders are interested in buying the

distressed property.

What does each stakeholder-party

to the SNDA want?

What does the hotel operator want? The hotel operator typically

wants the option to continue to manage the hotel for the full

contract term (with extensions) with a solvent owner — even

when the hotel fails to produce enough cash flow to service debt

and the owner is faced with foreclosure.

The principal motivations of the operator are purely economic.

Long-term management contracts are assets for the hotel

operator. They are somewhat like bonds or annuities, creating

streams of inflation-adjusted income for many years. The present

value of these income streams represents a significant asset.

Anything that could result in an early termination of this income

stream is a problem for the operator, including the ability of a

lender to terminate the operator on foreclosure (or sale by a

receiver, deed in lieu or bankruptcy court).

The hotel operator also wants to control the transfer of the

property, even on foreclosure, to be sure that the proposed

transferee is suitable from its perspective. For example, the hotel

operator wants to know that the new owner will not be a

competitor, has adequate resources to meet the owner's

obligations under the HMA, and get appropriate assumption

agreements whereby the new owner agrees to the terms of the old

HMA, or renegotiates a new one.

Operators would say that they want to protect their "distribution

system." They do not want their brand going up and down on

properties, confusing the public. They want the property to

continue shouldering its share of system costs (reservation,

centralized services, marketing, and support of national and

regional offices) and they want to continue managing the

property and earning their fees.

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What do lenders want? Initially, most lenders really want their

borrowers to perform according to the loan documents and pay

off at maturity. That does not always happen.

So lenders need both certainty and flexibility. They would like

certainty that a capable, professional hotel operator is running the

property to maximize cash flow and preserve the value of the

asset securing their loan. Operators initially gained their bargain-

ing power from the insistence of lenders and other investors that

the branded operator be "locked down" for 50 or 100 years, so the

lenders and investors would not have to worry about the

promoter (or managing partner) taking over the property and

destroying its value. The brands were happy to accommodate

being "locked down" as long as the property met their brand

standards, and the owner funded all deficits in operating cash

flow.

Normally, lenders would like the brand and operator to stay in

place even when loans go into default or foreclosure. They do not

want the asset to lose professional management, reservation

systems, or to suffer the significant cost and disruption of re-

branding. But to maximize the value of the hotel collateral, the

lenders would like for a potential hotel buyer (or the buyer at any

of the distressed sales) to have the right on closing the purchase,

or thereafter, to terminate the hotel operator.

Why would the lender want the ability to terminate the hotel

management agreement, or give that right to a buyer of the

distressed property?

Hint: A review of all the individual hotel purchase and sale

transactions of over $10 million per property throughout the last

40 years shows that in 80 percent of the transactions, the buyer

was either a hotel management company or a joint venture of a

capital source with a branded hotel management company. What

happens if the long-term management agreement cannot be

terminated on foreclosure or bankruptcy sale or on a deed in lieu

sale, and 80 percent of the typical buyers for the hotel don't bid

because they cannot substitute their management? What is the

impact on value?

The HMA & Franchise Agreement Handbook

In fact, when our hotel workouts team worked with major lenders

in the late 1980s and early 1990s, including acting as counsel for

the Resolution Trust Corporation (established out of the Savings

and Loan meltdown) in the resolution of many hotel

bankruptcies, the typical lender swore that it would "never again"

agree to an SNDA without the option to terminate the operator on

loan default or distressed sale. And that determination was strong

... at least for a few years until people forgot about what happens

in the bad times. In every economic downturn since the S&L

Crisis, lenders start to remember why their predecessors said

never again.

What do owners want? Hotel owners usually have the simplest

goal. They want reasonable freedom to get attractive financing for

the purchase, construction, improvement or equity take-out of the

hotel. They don't want to find that lenders are spooked by their

hotel management agreement, or that the terms of financing are

adversely affected. They want the hotel operator to give the lender

whatever is necessary to facilitate the financing and don't want to

be "held up" by the hotel operator when the lender needs some

accommodation.

And lending standards can change dramatically over relatively

short periods of time, at least when compared to long-term

management agreements.

What are the challenges?

Negotiating the subordination provision in a hotel management

agreement is challenging.

In a new development deal, the hotel owner frequently has to get

the operator before meaningful negotiations with the lender take

place, and therefore the HMA with the subordination provision is

usually in place long before talking to a lender. Also, many

owners and their advisors do not understand the importance of

this issue or ignore it until it is too late. Many owners are lulled

by the manager's assurances that the manager has great influence

with lenders, that lenders will be attracted to the project because

of the manager, and that a deal has never been held up because of

this provision. The last might be true, but that's only because the

borrower bears the cost!

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Lenders' standards are constantly changing. As lenders under-

write loans during times of easy credit, they are more likely to

accept some terms from managers that they will not during

challenging economic conditions. But since management agree-

ments can have terms of 20, 30, 40, even 50 years or more, owners

have to anticipate that they (or their buyers) will need to approach

lenders many times over the course of the agreement, not just

when the agreement is executed. The burden a subordination

provisions places on financing will undoubtedly affect the value

of the hotel through many transactions over the life of the

property.

What is the answer? How can you resolve the

conflicting interests?

There is no simple answer. Each situation is unique. You need to

understand how subordination provisions relate to your interests,

the entire agreement, the lending environment, and address it as

part of the overall relationship between owner and operator in the

hotel management contract.

The HMA & Franchise Agreement Handbook

Exculpation clauses — protecting the

owner's assets

his section briefly reviews the benefits to hotel owners in

including a provision in hotel management agreements

limiting the liability of the owner to its interest in the hotel

property. This kind of provision is commonly referred to as an

"exculpation clause," because it exonerates someone from blame

or liability. While this clause is in many ways basic blocking and

tackling, it is important to remember as acquisitions in the hotel

sector increase, and as owners renegotiate agreements with

brands and independent managers.

If you like the idea of both a belt and suspenders in any part of

your financial dealings or business life, please note that you will

rarely see an exculpation clause in a draft HMA from a hotel

management company. In fact we have not seen them in very

many HMAs drafted by others.

Why take a chance?

Limiting the hotel owner's liabilities under the HMA

Most hotels are owned in a special purpose limited liability

company or other entity designed to facilitate financing, and to

also limit liability to the assets of the hotel and its related business.

Sometimes operators will seek the personal guarantee of

individual owners or investors so that they will stand behind the

ownership entity's promises in the HMA, but most owners won't

consider that. And if there is any kind of reasonable equity

investment in the project, and appropriate insurance, personal

guarantees should be out of the question.

Limitations on liability in management agreements

Over the development of HMAs, hotel managers have become

more aggressive in limiting their liability for operating hotels.

These limitations include the indemnification provisions that

typically require the owner to indemnify the operator for all losses

or damages arising out of the hotel, unless it was caused by the

operator's gross negligence, willful misconduct, or breach of the

HMA. In other words, they are indemnified for their negligence.

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Some brands have also added limitations on claims to a fixed

amount (such as half the basic management fee), or "actual

damages," preventing the owner from making any claim for

consequential damages, punitive damages or other "extraordi-

nary" remedies.

These clauses are designed to protect operators, but rarely does

the operator's draft of the HMA contain any protections for the

owner. We have almost always been successful in making the

limitations mutual, and, in addition, we have successfully de-

manded protection for our owner clients from unwarranted

liabilities through an exculpation clause.

What does the owner's exculpation

clause look like?

While each situation is different, a typical exculpation clause

looks like this:

"Notwithstanding any other provision of this Agreement

to the contrary, the liability of Owner arising out of or in

connection with this Agreement and the transactions and

obligations contemplated hereby shall at all times be

limited to the interest of Owner in the Hotel, and in any

litigation or any other dispute, neither Manager nor any

other party shall seek or have recourse to any other asset

of Owner or to Owner's partners, members, associates,

agents, executives or Affiliates. Without limiting the

foregoing, neither Owner nor any party associated with

Owner shall have any liability in excess of Owner's

interest in the Hotel for any act by Owner, including

liability for the gross negligence, willful misconduct

(either prior to or during term of or after the expiration

or earlier termination of this Agreement) or breach of this

Agreement by Owner."

What does the exculpation clause do?

The purpose of the exculpation clause is to ensure that the liability

of the owner and its principals to the manager, and any other

entity making a claim under the management agreement, is

limited to the owner's interest in the hotel property itself. The

clause extends the protection to the principals and affiliates of the

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ownership entity, not just the owner. This clause covers not just

direct claims under the management agreement, but also any

claim arising out of the management of the hotel. The limitation

is important and meaningful — owners build or buy an expensive

asset and invest significant sums in its equity. A manager should

be satisfied that the substantial equity investment is adequate to

secure performance by the owner.

Why an exculpation clause?

It is generally possible to negotiate with a manager so that the

limitations on damages are mutual — that is, both the owner and

the Manager are limited in their claims. Moreover, hotels are

typically held in single purpose entities, which limits their

liability. Why is it preferable to include an exculpation clause?

While there are several answers, the key issue is that holding an

asset in a single-purpose entity, and limiting damages and causes

of action, does not prevent a manager or another party from

"piercing the corporate veil" and pursuing claims against the

principals of the owner. This is particularly the case because the

clause should include not just contract actions, but also other

claims which are more easily brought against the principals of the

owner.

Owners should also be aware that the asymmetry of the owner-

manager relationship militates toward ensuring, through all

possible means, that the owner is protected. The owner should not

lose sight of the fact that claims by an owner against a manager

may be difficult to prove. They often depend on subjective

measurements of quality, and often relate to matters where the

manager has more leverage. The manager, on the other hand,

typically seeks monetary damages based on fee calculations,

which are transparent (particularly where the manager has been

keeping the books)! Strictly defining the owner's potential liability

is, therefore, key to balancing the relationship.

CHAPTER 3

ABOUT FRANCHISE

AGREEMENTS,

BRANDS &

INDEPENDENT

OPERATORS

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Decisions about brands and

management

Branded vs. unbranded hotels, and branded vs.

independent operators

hen should you brand your hotel and when should you

leave it unbranded? How do you know when the benefits

justify the costs? And if you decide to brand, should you go with

brand management or an independent operator? What are the

considerations?

Few decisions are more important. Here are some insights

garnered by our Global Hospitality Group®'s experience in help-

ing clients with more than 2,700 hotel management agreements

and franchise agreements.

Why hotel branding and management decisions

are so important

One of the first decisions in the hotel development or acquisition

process can have a lasting impact on the success of the project:

whether the property should be branded, and whether that brand

should manage the property. The hotel's brand will be a defining

part of the profitability, image and value of the hotel, and there

may be no other decision which has a greater effect on the future

of the property. Similarly, the management of a hotel can enhance

the value of the brand, protect the owner, or detract from the

value of the hotel — by as much as a 50 percent swing.

The three fundamental questions

While a hotel owner will live with these choices for years — if not

decades — owners and developers often fail to ask three key,

threshold questions:

1 Should the hotel be branded?

2 If it is branded, which brand?

3 And if it will be branded, should the brand manage the

property?

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We recognize that there are many voices in the decision. Lenders

or other investors may be more comfortable when a hotel is

branded, and may feel that a brand manager will better operate

the hotel. Some investors may be predisposed to one brand or

another (often based on personal experiences as a guest, rather

than an owner), and may have preconceptions of the ability of

hotel ownership to operate the property. However, even where

these strong voices have input, the owner or developer should

consider the pros and cons of brands and brand management.

Four options available to hotel owners for branding

and management

At the outset, there are four basic choices available to an owner:

 Management by the brand, where a single firm will

agree to operate the hotel under a specific brand, and

the owner essentially hands the property over to the

manager with oversight rights and obligations

defined in a management agreement.

 A franchise with a third party manager. Here, the

owner enters into two agreements, one of which is a

license agreement with the brand, giving the owner

the right to operate a hotel under a specific brand,

and a second with a third party manager who will

actually operate the property.

 A self-managed franchise. In this case, the owner

obtains a license or franchise to operate under the

brand, but manages the property itself.

 Finally, an unbranded hotel, operated either by a

third party manager or by the owner.

Why a brand?

Brand standards and support. Brands provide many benefits. The

major brands establish standards, which are intended to be

consistent across all operations so that guests are better assured

that they will receive the level of service and amenities they desire

and expect, wherever the property is located. Along with

standards, brands provide operating manuals, which are

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intended to provide a "turnkey" approach to the operation of the

property. This is intended to reduce the number of mistakes and

help ensure that the property is, in fact, operated pursuant to the

brand standard.

Importantly, brands provide services that drive occupancy, such

as reservations systems, websites, brand marketing, loyalty pro-

grams, and quality control. While they are often cited as

important reasons to affiliate with a brand, they can be costly to

establish and maintain, and the direct benefit to the property is

not always apparent.

But are the benefits worth the cost? There are, however, a

number of reasons not to use a brand. The most obvious reason is

cost. Brands charge a variety of fees — management, royalty or

license fees, loyalty program fees, marketing fees, reservations

fees, training fees — the list can seem endless. Moreover, many of

the fees are unrelated to the brand's actual performance. Base

management or license fees and marketing fees are paid on gross

revenues, regardless of the source of the revenues. Thus, the

brand is compensated for occupancy even if the brand was not

responsible for it.

Similarly, brand standards, while benefiting the property in some

ways, come at a cost. These standards are designed to benefit the

brand, not a specific property. Even if a standard does not add

value to a property, the owner is obligated to adopt it because it

is a brand standard. Brand standards are generally inflexible, and

impose added costs on owners. Owners should also be aware

that, over the term of the management or license agreement,

brand standards change, and the driving force for the change is

usually to enhance the benefits to the brand as distinct from the

interests of owners.

Ill-conceived programs? More than that, some hotel programs are

ill-conceived or have wildly disproportionate costs to some

affected hotels and benefits to other. Over the past 35 years, we

have seen brands adopt programs to centralize sales, accounting,

quality control and other functions only to revert back to the prior

regime of decentralized services when they do not provide the

benefit promised. The cost of these programs are borne by hotel

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owners, and the cost is multiplied over the development of the

plan, its implementation, the struggles to overcome flaws, and

finally dismantling the plan. Brands have the luxury of

experimenting because they do not have to foot the bill.

Are expensive loyalty programs worth the cost? There is also a

big controversy as to whether loyalty programs actually benefit

hotels. Many analysts have called their effectiveness into

question. Again, the owner must consider whether their benefit is

worth the extra cost, both in terms of contributions to the loyalty

program and redemptions by guests. These programs are not

optional.

Issues with long-term commitments. Owners need to recognize

that both brand management agreements and brand license

agreements require a long-term commitment, measured in

decades. Brand affiliation agreements make it difficult, if not

impossible, for an owner to terminate for bad performance of the

operator. This lack of control can seriously depress the value of

the hotel at sale, or even lead to financial failure and foreclosure.

In addition, owners must take into account that the terms of these

long-term agreements do not protect owners from the possibility

of brand dilution or decline. There are a number of brands that,

over the years, rode a roller coaster of changing target markets

and ability to deliver on owner expectations. Many left owners

without expected support for years or declined in value.

Nonetheless, the owners were obligated to support expensive

brand standards and programs that did not deliver expected

benefits. (Radisson, Red Lion, Wyndham Resorts, Doubletree,

Westin, Sheraton, Amfac, and RockResorts to name a few). Some

brands recovered to varying degrees over years. Others did not.

Why not be independent?

Given that branding a hotel carries with it costs and burdens,

some owners consider whether it would be advantageous to go it

alone. Those who do cite a number of advantages:

 No license or system fees — at the outset, the owner

will save in the neighborhood of 10-15 percent of

gross revenues that it would otherwise pay to the

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brand for the right to operate under the brand name

and mandatory services.

 Greater flexibility to meet the market. While

unbranded properties don't have the support of

system standards, they also do not have to take the

good with the bad, and can structure a hotel

standard that perfectly meets their market. More-

over, they can experiment and change, which can be

difficult, if not impossible, in a brand's regime.

 Don't pay for what you don't need. There are some

instances in which a brand simply isn't needed. For

example, a hotel adjacent to a university hospital

might not need a brand affiliation. The location of the

property itself will put heads in beds and drive a

high occupancy.

Owners need to be aware, however, that taking the independent

route has its drawbacks as well.

 Unbranded hotels lose the benefit of a brand's

support system, including detailed operating

manuals and procedures, training, access to best

practices, and perhaps most importantly, the bench

strength and human capital that can make the

difference between a successful and unsuccessful

hotel. Many independent operators do, however,

have excellent support systems.

 Not having a brand also makes the owner rely on its

own resources and that of its on-site manager.

Placing the success of the hotel in the hands of the

wrong third party manager can be a risky venture.

Nonetheless, the right independent operator can

often bring better and more focused resources.

 An unbranded hotel will not have a dedicated

reservation or marketing system. While there are a

number of generic options available, they are not

necessarily designed to the specific needs of the hotel

or, conversely, require increased investment by the

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owner to create an effective reservation and

marketing program. However, the online travel

agencies (OTAs) and other viable alternatives are

now available to independent operators.

 An unbranded property is vulnerable to marketing

programs by larger, branded operators. With larger

marketing budgets, a branded property may be able

to compete more effectively with an unbranded

hotel. However, the saving in brand costs may be

more than adequate to provide more marketing in

the hotel's relevant markets.

Who should manage the property?

Once the decision is made about whether the hotel should be

branded or unbranded, the owner must address whether to have

the brand itself manage the property, or whether to seek a third

party manager (or self-manage).

Brand managers provide a number of benefits. They are closest

to the standard and how it is implemented; the brand cannot

argue that its own manager is failing to meet the operating

standard (unless the owner interferes with the process or fails to

provide capital). Some owners also see brand managers as being

the most efficient alternative, since typically only a single

management fee is paid, instead of a franchise or license fee and

a separate management fee. And in many cases, the brand

manager will have the deepest bench — the brand is likely to have

more experienced personnel who can parachute in to the property

to fill a vacancy temporarily, or to provide specific expertise on a

problem.

Brand management also comes at a cost. While the nominal fees

might seem to be less, brand operators are more likely to empha-

size the highest interpretation of brand standards and be less

concerned with achieving economies in operation or even

maximizing revenues. The primary concern of a brand operator is

the presentation of the brand, regardless of its economic impact

on the owner. To put it directly, the loyalty of the brand manager

is to the brand, not to the property. And to exacerbate the issue,

brand managers are difficult and expensive to oversee. Since they

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have full access to and control of the hotel, even understanding

where their operations might be improved can be difficult.

When is it appropriate to engage the brand to manage the

property? First, brands reserve the exclusive right to operate

certain of their flags. For example, Ritz-Carlton, Four Seasons, St.

Regis and other flags are exclusively operated by their

corresponding brands, since they are flagship properties and the

brands protect those standards jealously. It is the right choice

because there is no other choice.

In addition, certain types of properties, such as large, convention

hotels, require skills and expertise — and national group sales

offices — that have been developed by only a small circle of

operators. While there are a number of independent operators

that can operate larger hotels, the staffing, systems, and resources

of a branded operator will normally benefit hotels with more than

600 rooms, significant meeting space, and multiple food and

beverage outlets.

Conclusion

The decision to brand a hotel, the selection of the brand (if any),

and the selection of the manager are all interrelated and essential

decisions for the hotel owner. The outcome of the decision will

have a lasting impact not only on the current income and success

of the hotel, but also on the ultimate value of the property.

The HMA & Franchise Agreement Handbook

The myth that franchise agreements

cannot be negotiated

Eight things to negotiate in your next franchise

agreement

he main purpose of this section is to debunk the myth that

franchise agreements are not negotiable. Franchisors, given

the proper motivation, will negotiate certain franchise agreement

terms, particularly business issues that can have a real dollars and

cents impact; the key is to understand what is negotiable, what

will make the most impact, and how to get there. In these cases,

understanding what a brand has done and is willing to do will

create value. So, throw away your old conceptions!

As a "starter kit," we have listed eight areas that are frequently the

subject of negotiation in franchise agreements today. But there are

many more. And, you are missing out if you don't get advice on

what and how to handle your next franchise negotiation.

The ascendancy of hotel franchise agreements

Branded hotel franchise agreements continue their rise to

dominance in the hotel landscape. Branded hotel management

agreements are not dead, but the advantages of having a hotel

operator independent of the brand have been widely recognized

and continue to propel the franchise model. (The considerations

of branding and using branded — versus independent —

management are discussed at length in the previous section.)

Franchisees are told by the brand that the franchise agreements

are not negotiable, but then they hear that someone else has been

able to negotiate at least one or two contract terms. Potential

franchisees don't want to waste time chasing something they

cannot get, but the contracts seem so one-sided, and they want to

get as much substantive relief as they can.

The HMA & Franchise Agreement Handbook

The most common question we hear from clients is,

"What's really negotiable in a franchise

agreement?"

Based on our experience with more than 1,600 hotel franchise

agreements, JMBM's Global Hospitality Group® knows that there

is wiggle room to get some important concessions if you know

what to go for and don't waste your effort where it won't do any

good.

We have listed a few areas where we have been able to help

owners improve their contract terms. Depending upon your

circumstances, there may be other significant opportunities. It's

important to recognize that there is more room to negotiate

business terms than legal terms, and that spending time

negotiating some provisions can be counterproductive.

But, a word of caution! One of the biggest mistakes we see is

owners trying to negotiate the franchise terms themselves. Their

lack of experience shows that they are amateurs, and the brands

quickly realize that they don't have to give much by way of

concessions.

Setting the context: Understanding the

competing interests

Most branded hotel properties are operated under franchise

agreements which are long documents with lots of fine print.

They are usually presented to owners as "non-negotiable." This

brand position is justified on the basis of need for uniformity in

agreements and insuring that hotel guests will have a consistency

of amenities, operations and experience in all hotels bearing the

same flag.

However, hotel owners seeking a franchise also have legitimate

interests, and there needs to be some recognition of these needs

and the unique circumstances of every situation. In fact, our

experience shows that, within certain limits, some provisions of

these franchise agreements can be negotiated to address fran-

chisee concerns. Franchise agreements are not nearly as negoti-

able as hotel management agreements, so owners are well advised

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to understand what can and cannot be negotiated in order to

realize the greatest value from their relationship with the brand.

We have negotiated more than a thousand franchise agreements

with every major traditional brand (and most of the others), and

based on our experience, we believe there are key franchise

agreement terms that hotel owners should normally be able to

accomplish.

Eight things to negotiate in your next

franchise agreement

Here are eight of the most common franchise terms we are seeing

negotiated today:

1 Franchise and royalty fees. While it's unlikely that

franchise fees will be reduced for the entire term of the

agreement, a "ramp up" in fees over the initial years of

the agreement, particularly for a newly built hotel, can

often be achieved. While other chain fees are more

difficult to negotiate, it can be possible to get some

temporary relief there as well.

2 Area of protection or non-competition. Hotel owners

are properly concerned about the brand opening a

competing hotel within their property's market area. If

it's not offered, a franchisee should ask during the

negotiations for a geographic area of protection or non-

competition. The duration and area of protection of the

restriction varies, but some protection is usually granted.

3 Ownership transfer. Most franchise agreements are still

based on a simple ownership model, contemplating a

single owner (or investment group) of a single hotel. Our

experience is that more complicated owners (including

REITs, private equity groups, real estate funds and other

institutional investors) are increasingly focused on hotel

investments. As a result, the transfer provisions should

consider the structure of the owner and flexibility for

transfers to certain related parties. In that regard, while

a sale of a hotel often precipitates a property

improvement plan (PIP), the owners should not trigger

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a new franchise agreement negotiation, set of franchise

application fees and PIP when the transfer is to a related

corporate entity or to another family member or trust set

up for estate planning purposes.

4 Independent management and changes in

management. The essence of a franchise structure is

providing the power of a brand with the greater

flexibility and responsiveness of an independent

operator (i.e. an operator unrelated to the brand). A good

independent operator can provide an owner with a

valuable buffer to the brand's demands for operating

and capital expenditures, implementation of new and

expensive brand standards, property improvement

plans, and certain brand programs that may not make

sense for a given property. While brands are,

understandably, concerned that an operator must have

the experience to run the property, the management

company should be the owner's choice, and should have

primary loyalty to the owner, not to the brand. Thus, it's

important to prevent a franchisor from having veto

power over change in management of the hotel.

5 Liquidated damages. Liquidated damage provisions in

the franchise agreement give the franchisor the ability to

collect damages on the early termination of the franchise

agreement. They can be a key inhibitor to the owner's

ability to maximize the value of the property on sale,

because liquidated damages have ballooned in recent

years to large multiples of the average annual combined

franchise fees and reimbursements paid to the franchisor

(and in some cases, even more). While brands are

generally unwilling to negotiate liquidated damages

directly, understanding the impact and the conditions in

which they can come into play will allow for better

planning and execution.

6 Capital investments. Franchise agreements usually give

the brands the ability to require substantial additional

capital investments by owners to meet new physical

brand requirements. There are a number of ways to

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reduce an owner's exposure, including restricting time

periods and clarifying the types of capital improvements

that can be required. This is particularly the case for a

newly built property or an acquired property that may

have recently undergone renovation.

7 Personal guarantees. Most franchisors require

guarantees. Owners should seek to eliminate or restrict

the scope or amount of guarantees. As more and more

owners are institutional, this requirement is less and less

necessary to protect the brand's interests.

8 Key money. Many brands are willing to provide key

money as a means of securing franchise agreements.

While owners are typically excited about the prospect of

getting additional funds, they should remember two

things: First, key money is typically only paid after the

hotel opens; it doesn't provide funds for construction.

Second, and more importantly, key money is probably

the most expensive money an owner will get; in return

for key money, brands typically will be even less willing

to negotiate important franchise agreement provisions.

A nominal amount of key money is unlikely to benefit

the owner as much as it gives leverage to the brand.

While there are limited areas that an owner can expect to

successfully negotiate with a brand in a franchise agreement,

changes in these limited areas can make a big difference in the

value of the brand to the owner. Our expertise in understanding

how to implement these changes, and what other changes might

be appropriate in particular circumstances, has achieved signifi-

cant value for our clients.

The HMA & Franchise Agreement Handbook

The importance of comfort letters in

financing franchised hotels

f you are buying, building or refinancing a hotel, you'll almost

certainly be looking to a bank or other lender to finance it.

When you do, you'll need to negotiate dozens of documents, some

long, some short, but all of them necessary to get your loan. In

other sections, we have talked about the importance of

subordination, non-disturbance and attornment agreements

(SNDAs). SNDAs are used in the context of a hotel management

agreement — usually only long-term branded HMAs — to define

the rights of lenders vis-à-vis the hotel operator in the event of the

owner's/borrower's loan default, breach of the HMA, foreclosure

by the lender or a deed-in-lieu of foreclosure.

But what about franchised hotels? Lenders who take security in a

franchised property will want a "comfort letter," an agreement

between the lender and the franchisor defining the rights of the

lender with respect to the franchisor if the hotel owner defaults on

its loan obligations, the franchise agreement or other related

arrangements. In other words, lenders seek SNDAs to deal with

their rights and obligations with respect to HMAs. They use

comfort letters to deal with their rights with respect to franchise

agreements.

What is a comfort letter?

A comfort letter is, essentially, a form of assignment of the

franchise agreement for the hotel brand. It governs the ability of a

lender to operate a hotel property under a brand name after a

foreclosure, receivership or other loan default.

Why do lenders want a comfort letter?

Lenders make loans on branded hotels because they believe that

a hotel is more valuable if it can be operated (and sold) as a

branded property. If the hotel franchise agreement is terminated,

the value of the property could drop significantly. Even where

there is no foreclosure, the lender may want the ability to be able

to "step into the shoes" of the borrower and continue to operate

the property under the existing hotel franchise agreement. More

than that, a lender will want to be able to sell the hotel after

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foreclosure (or in connection with a receivership or similar

action), and may believe that transferring the franchise to a buyer

will increase its recovery. This, of course, requires the consent of

the franchisor/hotel chain.

Who writes the comfort letter?

Most hotel brands have a standard form for a hotel comfort letter

and, as a practical matter, brands will insist on negotiating from

this form. When parties ask a hotel brand to use a new or different

form of comfort letter, the brand may refuse or, at best, it will

delay loan closing until the negotiation over the form of comfort

letter is concluded. While the lender's rights under the comfort

letter are limited, most institutional lenders have been willing to

accept the comfort letter as providing the lender with sufficient

"comfort" that it will have the ability to maintain the franchise

relationship and the value of its collateral in the specified events

of the owner/borrower default.

What's in the comfort letter?

While each hotel chain's form of comfort letter differs to some

extent, most comfort letters have the following provisions:

 The lender wants the brand to give the lender notice

and right (but not obligation) to cure any default by

the borrower under the franchise agreement prior to

a termination of the franchise agreement.

 The lender wants the ability to assume the franchise

agreement and avoid the payment of the application

and other initial fees charged to franchisees. Hotel

chains will often charge a lender a "processing" or

administrative fee, which is less than the initial fee

usually charged to a new franchisee.

 The lender wants the ability to have a receiver oper-

ate the property under the terms of the existing

franchise agreement, at least for a short period of

time during the foreclosure phase. Most hotel brands

are generally willing to allow the receiver to operate

the hotel under the "franchise flag" for a relatively

short period, provided: (a) any monetary and non-

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monetary defaults are cured promptly; (b) the hotel

continues to maintain the insurance coverage

required by the franchise agreement; and (c) the

lender guarantees the obligations of the receiver

under any short term license issued.

 If the lender acquires the hotel property as a result of

foreclosure, it will typically want to sell the property

quickly. As a result, the lender wants to obtain some

assurances that the purchaser can also obtain a

franchise agreement with the hotel chain.

 In addition, most lenders would like to be released

from liability under the franchise agreement once it

sells the hotel to a third party purchaser. Most hotel

chains are willing to agree that, in the event of a sale

of the hotel to a third party that party can apply for

a franchise agreement and that such application will

be processed in accordance with the franchisor's then

existing requirements and procedures.

What's the challenge?

Comfort letters, while a key requirement for most lenders, are

challenging to borrowers because they require the lender and

franchisor to come to agree on matters that have no immediate

effect on them (or on the borrower!), but can prevent the closing

of critical financing. Moreover, the lender and franchisor may

have a different agenda than merely facilitating the closing of the

owner's/borrower's financing transaction. For example, the

lender may have other issues with the borrower, and the borrower

may still be in the throes of finalizing the franchise agreement.

Even in the best of situations, the borrower's counsel is often

saddled with the task of negotiating a comfort letter that his or her

client has little interest in, and trying to mesh the sometimes

incongruent interests of the lender and the franchisor. The

ultimate payoff to the borrower, of course, is the making of the

loan by the lender.

The HMA & Franchise Agreement Handbook

Brand franchise issues in hotel

purchase and sale transactions

Key issues in hotel purchase agreements for buyers

and sellers of branded hotels operating under

franchise agreements

uying or selling a hotel operating under a brand name

requires special attention. Typically, the existing franchise

agreement will be assumed, terminated or modified in some way,

and the new branding arrangements will usually have a

significant impact on the value and profitability of the hotel. The

JMBM Global Hospitality Group® has represented buyers and

sellers of hotels with all the major hotel brands, and has

developed practical solutions to achieve a smooth transition of the

franchise from the seller to the buyer, or to change the franchise if

that suits the buyer's goals. Knowing when and how to work with

the franchisor as part of the transaction can save both parties a lot

of money, avoid major disruptions of hotel operations upon the

sale and increase the value of the property itself.

In this section, we discuss some of our experience dealing with a

few key hotel franchise issues that need to be addressed during

the hotel purchase and sale agreement negotiation and during the

transition process.

The first thing you need to know: The franchise does

not follow the property. It terminates on sale.

Some hotel buyers and sellers believe that the hotel brand can be

sold along with the hotel. That is not true. Virtually all franchise

agreements currently used by the major brands provide that the

seller's existing franchise agreement terminates when the hotel is

sold. The buyer will need to apply for, gain approvals and then

enter into a new franchise agreement if the buyer wants to retain

the brand. This leads to two key concerns.

First, unless a franchisee (the seller) has negotiated otherwise with

the franchisor, the sale of the hotel will cause the termination of

the franchise agreement, obligating the seller to pay a significant

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termination fee. While most franchisors will waive the

termination fee when an approved buyer enters into a new

franchise agreement, the transaction documents, conditions and

timeline must deal with this reality.

Second, the new franchisee (the buyer) must make independent

arrangements with the franchisor to continue to operate the hotel

under the same brand (if it chooses to do so), starting on the day

the transfer takes place.

The hotel purchase and sale agreement should address these

concerns. For example, the seller might include provisions in the

hotel purchase and sale agreement to require that the buyer

receive approval from the franchisor, and a new franchise

agreement from the franchisor, before the closing of the transfer.

If the buyer intends to change the franchise, then the seller needs

to take into account the termination fees that the franchisor will

charge for termination of the franchise. The seller may also want

to increase the purchase price or negotiate terms with the buyer

that reflect the seller's payment of any franchise termination fees.

The parties' respective obligations to effectuate the transition

should also be spelled out.

The hotel purchase agreement must allow enough

time to complete the new franchise approval

Hotel franchisors have an application process, which requires

detailed background and financial information from the prospec-

tive hotel buyer before they will accept the buyer as a new

franchisee. The seller will want to find out how long the franchisor

will take to review the buyer's franchise application. The buyer

needs to be prepared to file a franchise application and to submit

the necessary background and financial information to the

franchisor as early as possible. A franchisor can take several

weeks to review a franchise application from a new franchisor.

Less time may be required for a buyer who already operates other

hotels under the same franchise, but the buyer will generally still

need to submit a new application and obtain franchisor approval.

The franchisor may also require the buyer to commit to upgrades

of the hotel as a condition of approval (more about that next). The

buyer will want to review the franchise agreement presented by

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the franchisor, and perhaps negotiate a few modifications. The

seller and buyer need to provide time in the transaction process

for the buyer to go through the approval and negotiation process

with the franchisor before the closing. Once the buyer and the

franchisor have agreed to the terms of the new franchise

agreement, it may take additional time for the buyer to receive the

signed franchise agreement from the franchisor. It is prudent for

both the seller and buyer to wait until after the buyer has a signed

(new) franchise agreement before closing the sale of the hotel.

For the buyer: How to deal with PIP requirements

Almost every hotel franchisor will require a new franchisee to

undertake a property improvement program or "PIP" as a

condition of receiving a new franchise agreement. If the hotel has

not been upgraded for several years, the franchisor may require

the buyer to make a substantial investment in property upgrades.

If, on the other hand, the seller has recently made upgrades, the

buyer may be able to reduce the required improvements, and/or

to negotiate a longer time period after closing for the buyer to

complete property improvements.

The buyer will want to start the discussion process with the

franchisor early in the purchase transaction, so that the buyer can

determine the costs of the improvements being requested by the

franchisor, and be prepared to discuss a timeline with the franchi-

sor to manage the costs and operating disruptions that will be

required for the upgrade. Inexperienced buyers will want to

engage knowledgeable consultants to help review and evaluate

the franchisor's requested improvements, and suggest "value

engineering" modifications to the franchisor's property improve-

ment plan to reduce the buyer's cost.

For the buyer: How to negotiate with the franchisor

for better terms in the franchise agreement

Although many of the terms of a franchise agreement will not be

negotiated by a franchisor, there are some provisions that are

negotiable. Some of the most frequently negotiated provisions

include:

 Lower initial franchise fee rate, with a ramp-up in

franchise fees over time

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 Include or expand an area of protection or restricted

area within which the franchisor will not issue new

franchises for the hotel brand

 Permit transfers to certain of the buyer's internal

affiliated persons or entities and to accommodate

certain financial arrangements

 Eliminate any of franchisor's right of first refusal,

right of first offer, or right of first negotiation

 Eliminate or reduce termination fees for the future

sale of the hotel by the buyer

 Establish some protection or standard before the

franchisor can require the buyer to make future reno-

vations

Another major issue for negotiation will be the guarantees that the

franchisor requires from the buyer and its affiliates. Buyers

should be aware that there are different forms of guaranty, and it

is possible to negotiate a guaranty that will reduce the potential

liability of the guarantor. For additional recommendations on

Hotel Franchise Agreements, see The five biggest mistakes hotel

owners make in selecting operators and negotiating brand HMAs at

page 9.

For the seller: How to deal with liquidated damages

Most hotel franchise agreements require an owner/seller to pay a

termination fee or liquidated damages on termination of a

franchise. Often this amount will be a multiple of the average

annual franchise fee earned by the franchisor over the prior years.

The franchisor may also charge the seller other fees, such as

charges for the hotel signs that the franchisor leases to the seller

for a fixed term. The seller will want to ask for a waiver of all

liquidated damages, which the franchisor will often grant, as long

as the buyer enters into a satisfactory new franchise agreement

with the franchisor. The seller should not allow a buyer to close

on the hotel purchase before the seller has obtained a waiver from

the franchisor and the buyer has obtained a new franchise

agreement from the franchisor.

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Unless there is a specific condition in the contract, even if the

buyer is obligated by the purchase agreement to execute a

franchise agreement after the closing (and does so), the franchisor

has no obligation to waive termination fees. And of course, if the

buyer does not enter into a franchise agreement after the closing,

the franchisor can demand that the seller pay all of the

termination fees and charges.

Often times, such termination fees and related charges are secured

by the personal guaranty of the owner/seller, which means that

the franchisor can sue the owners directly for these amounts.

Therefore, it is critical to the seller to obtain the waiver of

termination charges by the franchisor before the closing.

For the buyer: How to coordinate a de-branding if

the hotel is changing flags

If the buyer intends to change the hotel flag, the process of

removing the old name and replacing it with the new name will

require coordination and timing. This is typically done by the

buyer immediately following the closing, in accordance with a

pre-arranged schedule. The buyer will want to coordinate with

the franchisor, because hotel brand signs are often leased, rather

than owned, by the seller. In addition, all items with the old hotel

brand name and logo will need to be removed from the hotel and

replaced.

In addition, a change of hotel brand will likely also mean a change

of reservation systems. This may necessitate replacement of

existing technology at the hotel to accommodate the new

reservation system and training of personnel who are not familiar

with the new system. The buyer will want to be in a position to

immediately turn on the new reservation system when the old one

is turned off, to avoid a disruption in bookings. If the hotel does a

significant amount of group business, the buyer will want to

discuss existing group bookings with the franchisor, and if

possible obtain a commitment from the franchisor to leave the

existing group bookings in place without soliciting the groups to

move to another hotel within the franchisor's system.

At the same time, buyers should be aware that franchisors often

steer bookings away from properties when those properties

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change brands. Thus, the buyer needs to start marketing the prop-

erty as soon as possible to avoid unreasonably low occupancy

when the hotel opens under new ownership and brand.

For the buyer: Obtaining approval of the hotel

manager and the right to change managers

The hotel buyer will often bring in an independent hotel

management company to manage the hotel under a hotel brand

franchise agreement. Since the hotel franchise agreement will

include a provision that requires the franchisor's approval of any

third party manager of the hotel, the hotel buyer will need to

confirm early in the transaction that the franchisor will approve

the buyer's choice of hotel manager. For future flexibility, it is also

wise to negotiate for the ability to change hotel managers without

the franchisor unreasonably withholding its consent.

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Dual-branded hotels — what every

owner or developer should know

The growing trend of dual-branded hotels

ual-branding of hotels in a single structure or complex is

quite a trend in the hotel industry and has been picked up

by the popular press.

The hotel lawyers in JMBM's Global Hospitality Group® have

worked on dual-branded hotels since the early inception of the

concept, so we thought we would share some our observations on

the pros and cons of this approach.

One building — two brands:

Two sides to the dual-branding coin

USA Today has reported that hotel chains are increasingly offering

owners and developers a "two-for-one" deal — a single building

housing two separate hotels. While this is not entirely new (hotel

companies have been placing multiple brands adjacent to each

other or sharing facilities for many years), the trend of "dual-

branding" is accelerating. JMBM's Global Hospitality Group® has

worked on a number of these projects, and sees both benefits and

challenges in this trend.

Here are a few of the considerations that we have noticed.

Benefits of dual-branding hotels

Probably one of the most appealing parts of a two-brand, one-

building approach is the ability to maximize the value of land,

which is one of the biggest costs of developing a new hotel

property. Hotel brands typically provide for a range of room sizes

and configurations in any single hotel. By effectively putting two

hotels on a single parcel, a developer can increase the number of

guest rooms and provide a greater variety of guest room types to

maximize the revenue from that property.

Different brands from the same brand family can also appeal to

broader range of guests. For example, Hyatt Place and Hyatt

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House properties are often co-located, making it possible to offer

both a select service hotel and an extended stay property. And at

LA Live in Los Angeles, Marriott International has combined a

Ritz-Carlton and a JW Marriott Hotel on the same property. In a

separate building across the street, Marriott co-located a

Courtyard by Marriott and a Residence Inn. That gives Marriott

four Marriott-family brands to offer guests in two buildings!

Locating two hotels in a single property may also permit more

efficient use of space. The two hotels sharing a building may be

able to share costly parking, pool, fitness center facilities, meeting

space, restaurants, retail areas and engineering facilities, which

would otherwise have to be duplicated.

Just as important as maximizing the efficiency of physical space is

the cost savings that may be achieved in operational efficiency. It

may not be effective to have a full time chief engineer or

accounting staff for a single, 100-room hotel, but it may work if

they service two co-located hotels with a total of 250 rooms.

Similarly, having more hotel rooms operated in the same

building, by the same brand, has some potential for greater

flexibility and scalability with other personnel (housekeeping,

maintenance, front desk and so on), and thus can reduce

employment costs and increase efficiency.

Challenges of dual-branding hotels

While there are clear advantages to putting more than one hotel

in a single property, there are a number of challenges as well. One

of the key challenges an owner will face in a dual-branded

property is that different brand families generally refuse to

cooperate on a dual branded property. It is virtually impossible to

imagine two different brands would agree to operate hotels in the

same building. So even if the owner felt that a Hilton hotel and a

W hotel would be the perfect mix, if they ever did both occupy the

same building, they would never share operating space, facilities

or personnel.

Even mixing two brands from the same brand family can be tricky

when the two brands are far apart in typical guest profile — the

amenities of a luxury hotel would be compromised by sharing

space and personnel with a limited service hotel. For that reason,

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most of the dual-branding efforts have been with brands that are

fairly close on the brand family chain scale. At the same time,

putting two very different brands together can muddy the

differences between different offerings.

Owners should also consider financing issues. Financing lenders

may want to aggregate cash flows from the two hotel operations

for debt service coverage ratios and other benchmarks for internal

credit purposes. At the same time, they would normally also want

separate legal parcels for each hotel for remedy purposes. This

adds a few complications (generally not insurmountable) to

negotiations and transaction costs, that should be more than set

off by cost savings and efficiencies of dual-branding.

In the typical dual-branding situation today, the properties would

normally both be managed under a single management

agreement, or at least by a single manager, so as to achieve the

greatest operating efficiencies. Under a single agreement, the

manager would combine the financial results of the properties

together, and would apply a joint performance test. While that

would avoid some of the problems of running two separate hotels

in one building, it would also tend to hide the actual performance

of the individual hotels. It would also mean that if the owner

wanted to terminate the manager of the non-performing hotel, it

would also have to terminate the performing hotel. These issues

can all be dealt with in management agreement negotiations if an

owner or developer is well-advised.

At the same time, if the dual-branded hotels operated under

franchise agreements, they would require two different franchise

agreements. Franchise agreements for dual-branded properties

need to have customized approaches, contact provisions and

operating procedures to optimize the benefits of dual-branding.

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Five things to keep in mind when you

look for a hotel operator

Setting the record straight on HMAs

ver the past several months, a lot has been written about

what hotel management agreements should or should not

say. The Global Hospitality Group® at Jeffer Mangels Butler &

Mitchell has been negotiating, re-negotiating, litigating, arbitrat-

ing and advising clients for more than 35 years on more than 2,700

hotel management agreements and franchise agreements. Our

experience extends to virtually every brand and every significant

independent manager, as well as many less well-known players.

Based on that experience, we thought it would be helpful to set

the record straight on some key issues that owners need to

consider.

1. Owners and managers are not partners. One of the

common statements we hear from owners and managers is

that the management agreement "aligns the interests" of

the owner and the manager, and that the manager is "just

like a partner" in the hotel. While the interests of the owner

and manager can be reconciled, they are not

aligned — even when the operator makes an equity

investment in the hotel. Managers are focused on

maximizing their portfolio and overall revenue, while

hotel owners are concerned about the value and income of

a single property. Managers can "sacrifice" the profitability

of a single property so long as the value of their portfolio

is enhanced and they get their money off the top from gross

revenues, whether or not the hotel is profitable. Owners

expect to profit from each property.

2. Managers are NOT taking ownership risk. While it's true

that hotel managers take on some costs and risk in

managing a property, the fact is that in almost all cases,

their risk is dwarfed by the owner's risk. Owners are

responsible for funding all of the costs of the hotel,

regardless of its profitability; managers are not. Those who

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raise funds for charities often refer to the difference

between "involvement" and "commitment." And they like

to make an analogy to a ham and egg breakfast, where they

say the chicken was involved, but the pig was committed.

In the world of hotels, managers are "involved," but

owners are "committed."

3. The hotel management agreement is important. Many

commentators, including those with experience in the

industry, argue that the manager's track record is more

important than the management agreement. We agree that

an owner should verify the manager's track record before

making a commitment. However, the track record alone is

not enough. First, while every management company has

a list of highly touted successes, every management

company also has a less-publicized list of disappointments

— the track record goes both ways. Beyond that, a hotel

management agreement is a complex document that

identifies the expectations of parties for a period of five,

ten, twenty, fifty years or more. Over that period of time, a

good track record can turn into a disappointment, and

relying on decades-old assumptions may be disastrous.

4. Owners need meaningful approval rights. All of these

factors lead to a key conclusion — owners need to have a

meaningful say in hotel operations. While owners hire

managers to operate properties because of their expertise,

resources, personnel and reputation, the relationship

between owners and operators is "asymmetrical," and the

goals of the two differ. While managers like the idea of a

70s-style management agreement, where the owner simply

hands the keys to the manager and hopes for the best,

today's owners are vitally interested in operations. This

means that owners should have clear oversight and

approval rights over budgeting, expenditures and key

operating decisions. They should not be dissuaded from

exercising those rights because of an operator's track

record.

5. The gap can be bridged. Despite the differences between

owners and managers, the gap can be bridged, but to do so

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requires expertise and experience in the options and

alternatives available to the parties. From the owner's point

of view, an attorney that understands what managers need

and how their requirements can be met, is essential. Just as

important is bringing to the table advisors that can

recommend meaningful and practical compromises, and

who are known to be credible players in the industry.

CHAPTER 4

HOW TO TERMINATE

A HOTEL

MANAGEMENT

AGREEMENT

The HMA & Franchise Agreement Handbook

What can you do when an HMA isn't

working?

here are always disputes between hotel owners and

operators, and most of them are resolved without any legal

action. But some disputes advance into litigation with the filing of

a complaint, and others go to arbitration. The choice between

litigation and arbitration is normally controlled by the terms of

the management agreement.

The number of owner-operator battles ebbs and flows with

economic cycles, escalating substantially in difficult times as the

survival of many hotels teeter on the brink. What the public sees

is just the tip of the iceberg.

Setting the stage: the owner-operator relationship

The relationship between a hotel owner and hotel operator is

complex. While the owner bears the financial risk of the hotel's

success or failure and its gain or loss in value, the operator has the

exclusive right to manage the owner's business and is paid "off the

top", whether or not the hotel is profitable. The hotel management

agreement typically transfers and entrusts control of the hotel's

assets to the operator, while the owner assumes the costs and risks

of operation.

Hotel owners nationwide are increasingly aware of both the

benefits and impediments of long-term hotel management

agreements with branded operators (and nearly all such contracts

are long term, often running 40 or 50 years). On the upside, the

brand can provide stability, consistent standards, a reservation

system, marketing expertise and professional staffing.

The downside can be hard for owners to live with — brands can

incur needless expenses, be unresponsive to market conditions, or

even indifferent to the owner's need to run a profitable business

and protect an asset.

While the majority of hotel owners and operators work hard to

achieve a balance that is a win-win for both parties, it is easy to

understand how things can go badly, quickly.

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The root cause of owner-operator disputes

When problems boil over, at the heart of the matter, usually you

will find the owner believes that the operator is not running the

hotel in a satisfactory manner, and is treating the owner unfairly.

Often, the operator is the only one in the relationship to make any

money.

Operators don't want to give up their lucrative management

agreements, and many of them can't, or won't, change their

actions to satisfy owners who bear all the financial risk of the hotel

investment. Owners may find themselves dipping heavily into

other funds to meet negative operating cash flows or mortgage

payments. Many face foreclosure — and loss of their entire

investment — with the operator's sub-par performance. Owners

feel cheated when operators continue to take their money off the

top (from gross revenues) and won't cooperate to improve the

owner's unprofitable situation.

When hotels operate at a loss for a sustained time, tensions

increase sharply. Operators are in virtually complete control of

the hotel. All the activities that might generate income, from the

talents and skill sets of the people they hire at the property and

corporate level, to what marketing programs they develop and

deploy, and how they tap into corporate or other resources to

develop business at the hotel. They also control (or fail to control)

hotel expenses. For example, the operator determines which

restaurants to keep open, what hours concierge service will be

available, and what amenities are offered to guests. The operator

sets the prices for everything at the hotel, and determines staffing

levels.

Under these circumstances, owners feel helpless and often seek

cooperation from operators to reduce losses and create a profit or

break even. When the operator controls all aspects of hotel

operations, who is to blame for sustained bad results? Often

owners do not feel that operators are doing enough, and may

want to force some kind of change in operations or even a

termination of the relationship, feeling that almost anything has

to be better than what they are stuck with.

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At the same time, operators tend to feel that they are doing the

best they can under difficult circumstances. They have their own

profit situation to monitor and their own shareholders to satisfy.

They may also feel they must maintain the integrity of their brand,

and that compromises for a short-term benefit to an owner may

cause long-term damage to the operator's reputation. Operators

often say that they made a deal with owners, and the owners

should live up to their agreement and provide whatever resources

it takes to ride out the downturn or other difficulty.

When the economy adds financial stress

The tension between owner and operator is ever-present, but

exacerbated in difficult financial situations. Clearly, bad economic

times create more friction between hotel owners and operators.

When all stakeholders in the hotel are making lots of money,

owners and operators aren't motivated to correct every wrong.

When hotel operations hit the skids, and owners have to write

checks to keep the doors open, they want fast and responsive

cooperation on critical issues.

Wrestling over approving budgets and forcing compliance often

depends upon the terms of the HMA. Some HMAs give owners

no right to approve any budgets, while others give limited rights,

leaving the operator in control while disputed line items are

arbitrated. Too often there is no standard for how the arbitrator is

to decide whether to allow the disputed budget item, except for

the operator's "brand standards." And how can an owner prevail

when the branded operator insists the budget item is necessary to

maintain the standards it establishes?

Most owners become incensed when they feel that their operator

is not responding to a critical situation. The aggravation level

escalates when the operator isn't proactive in driving business,

cutting costs and better managing capital expenditure issues.

Whatever the reasons, bad financial results can severely wound

owners and lenders who feel they are entitled to expect results

from operators who proclaim their expertise and take their money

off the top — as a percentage of gross revenues, or through

markups, purchasing fees, reservation fees, frequent traveler

charges, and the like. They are dismayed when the operator is

unable or ineffectual at getting results.

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What happens in hotel management

agreement lawsuits?

ost branded hotel management agreements run for

decades. They are not terminable just because the hotel is

underperforming. They usually have very tricky procedures

requiring notice of perceived breach, with one or more

opportunities for the operator to "cure" the default. Operators

design their management agreements to make them difficult to

terminate. If an owner terminates the management agreement

and does not have proper justification, the owner will be

responsible for damages for breach of contract, which could

amount to the net present value of the income stream the operator

would have received for the remainder of the contract term. This

could be very expensive. Nonetheless, some owners are willing to

pay the price to unencumber the hotel and remove an ineffective

operator. There are times when the cost of terminating an

agreement, however high, is less than the cost of a weak operator.

When disputes between owners and operators escalate to

litigation, decisions of the trial court may be brief and difficult to

find. The decisions are less likely to be published, and often are

not accompanied with rationale underlying the court's decision.

Only cases that have been appealed and decided by appellate

courts result in reported decisions, which become part of our case

law and precedent for other cases.

That said, the reported case decisions on owner terminations of

operator management agreements are typically favorable to

owners in that the HMA generally creates an "agency

relationship." This means that there is an absolute right of the

owner to terminate such contracts (though the owner may be

subject to damages), and that this agency creates fiduciary duties

imposed on the operator.

There is no way to know how many unreported lawsuits or

arbitrations may exist on this matter. From our own experience,

we would say that disputes are not uncommon, though most are

resolved or settled prior to decision.

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100

Important cases impacting today's HMA litigation

There is a long history of brands resisting owner terminations,

and court battles emanating from the 1991 Wooley vs Embassy

Suites through 2012's Marriot vs. Eden Roc, both of which have

defined how hotels and operators interact with each over the last

30 years.

A brief summary of important cases follows.

Woolley vs. Embassy Suites

Woolley vs. Embassy Suites in 1991 was the first case to establish the

precedent that the owner/operator relationship is one of "agency"

— one company providing services to another for a fee. Agency,

as defined by English common law for hundreds of years,

includes obligations to act in the principal's (in an HMA, that

would be the hotel owner) best interest, and also stipulates that

the principal can terminate the relationship at any time.

In Wolley, Robert Woolley and Charles Sweeney owned 22 hotels

throughout the country, all of which were managed by Embassy

Suites. Woolley/Sweeney sued Embassy for termination in

January 1990. The eventual outcome of the suit was a decision

affirming the agency relationship between the parties and

determining that an owner could terminate an HMA at any time,

although it may face damages or other consequences.

Turnberry Isle vs Fairmont

Turnberry Isle vs. Fairmont further cemented the ability of owners

to terminate HMAs, even if the contracts said otherwise. The

Turnberry Isle Resort & Spa, in Aventura, Florida (near Miami)

was owned by Turnberry Associates, and was operated by the

Fairmont chain under a 50-year management contract.

Dissatisfied with the operator's performance, Turnberry

undertook terminating the relationship.

Turnberry's strategy included a surprise takeover of the resort,

ousting Fairmont and terminating the management agreement

without any advance notice. On the morning of August 28, 2011,

Turnberry informed Fairmont that they were de-branding the

resort, and directed Fairmont to immediately leave the property

escorted by an outside security team. Turnberry then changed the

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101

branding of the hotel, from napkins to marquees, retained

employees loyal to Turnberry, switched to a different room

reservation system and website, and removed all references to the

Fairmont name.

Two days after the takeover, Fairmont sought emergency relief in

federal court to get back into the hotel. After a hearing on the

matter, complete with testimony from top executives of Fairmont

and the hotel owner, as well as industry experts, the court ruled

against Fairmont. Turnberry maintained control of the operations

of the hotel and Fairmont was not reinstated.

The Fairmont court had a clear grasp on extremely complex and

difficult legal issues. Both federal judges in the case

independently came to the same conclusion: Turnberry had the

power to terminate the 50-some-year agreement, despite the

agreement's express provisions to the contrary. A year later, the

court dismissed Fairmont's lawsuit for damages because the

parties had reached a settlement.

Marriott International vs. Eden Roc

Marriott International vs. Eden Roc defined the relationship

between owners and operators outside of the "agency" principle.

In March 2012, Key International, the owner of the Eden Roc hotel

in Miami Beach, terminated Marriott as the hotel's operator

"following years of mismanagement of the property and a failure

to maximize the Eden Roc brand," according to its news release.

Marriott refused to acknowledge the termination or vacate the

hotel. In October 2012, Eden Roc attempted to remove Marriott

from the hotel's premises, but Marriott refused and obtained a

temporary restraining order barring the hotel's owner from trying

to oust it as Eden Roc's operator.

Key International appealed the decision and in March 2013, a

New York appeals court issued an order vacating the lower

court's injunction. Key International was free to terminate

Marriott as Eden Roc's operator. Under this decision, virtually all

existing hotel management agreements became terminable at will

by owners.

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Marriott International v. Eden Roc reaffirmed the "power" of an

owner to terminate a hotel management agreement and to regain

control of its property for any reason. However, if the owner does

not have the "right" to terminate the agreement — adequate legal

justification such as a material breach by the operator — then the

owner will be liable to the operator for damages resulting from

terminating the contract. Those damages may be very substantial,

and no owner should undertake a termination of a hotel

management agreement without legal advice on alternative

approaches, as well as the potential consequences of the action.

In the Eden Roc decision, the appeals court agreed that the hotel

management contract "is a classic example of a personal services

contract that may not be enforced by injunction." At first blush to

someone outside the hotel industry, this case might have seemed

unremarkable. It restated and affirmed legal principles that have

been used throughout the United States for more than a century

regarding personal services contracts.

The fact that the Eden Roc decision was based solely on the use of

an injunction to enforce a personal services contract, however,

was novel in the hotel industry. Up to that time, all other hotel

terminations were based on agency principles. Notably, in Eden

Roc, the court did not rely on agency principles at all. In fact, the

court stated that it found no agency relationship under those facts.

After a few high profile lawsuits over the termination of hotel

management contracts, many operators had accepted that under

the typical hotel management agreement the operator would be

the "agent" of the owner, with all the attendant implications of

fiduciary duty. These operators did not fight the basic concept

they were subject to the "cardinal rule of agency" that a principal

(the owner) always has the power to terminate his agent (the

operator).

Marriott and a few other operators, however, took a different tack.

They sought to strip their management contracts of any "agency"

overtones or language, while retaining complete control over

hotel operations. These contracts apparently confused some of the

lower courts into thinking that because they purported to be non-

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103

agency contracts, they must be so, and therefore could not be

terminated under traditional agency principles.

The Eden Roc court noted in a one-sentence conclusion that the

hotel management agreement did not create an agency

relationship. In denying the agency relationship, the Eden Roc

court gave owners a tool potentially even more powerful than the

agency relationship when it comes to getting control of a hotel

back from an operator.

Although these three cases have had a significant impact on how

owners and operators manage their relationship and proceed

with terminations, they are now 10 or even 30 years in the past.

New laws and new, potentially precedent-setting cases are

changing the landscape. Virtually every hotel manager now takes

the position, and includes in its standard agreements, provisions

disclaiming fiduciary obligations. In 2004, Maryland adopted a

statute governing hotel management agreements and it is worth

an in-depth examination, as it has significant consequences for

owners and operators throughout the country.

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Maryland law changes historic

prevailing rights and remedies in HMA

and franchise litigation

he choice of governing law provision of your HMA or

franchise agreement can have a significant impact on the

rights and remedies of the parties under the agreement. This is the

provision that is usually found near the end of the agreement. It

may have a caption like "Governing Law" or "Applicable Law," or

it may be one of many subsections of the "Miscellaneous"

provisions. It may be combined with other provisions or set out

in a separate provision. Wherever located, the essence of the

choice of governing law provision will contain something like the

following:

This Agreement shall be construed in accordance with

and be governed by the laws of the State of Maryland

without recourse to its choice of law or conflict of law

principles.

In most contract negotiations, the choice of governing law is not a

very controversial issue. In the context of HMAs and hotel

franchise agreements, however, insertion of this choice of law

provision (or acceptance of it) deserves careful consideration. This

choice of Maryland law changes certain important rights and

duties of the parties from historic prevailing common law and

statutory provisions to the contrary in every other jurisdiction of

the United States. These Maryland statues were adopted by the

Maryland legislature in 2004 in response to the hotel brands'

political influence as one of the largest employers in that state.

The state of Maryland has a unique statutory scheme designed to

prevent an owner's termination of a franchise agreement or hotel

management agreement, absent some uncured breach of the

agreement by the operator that would entitle the owner to the

express contractual right to terminate.

The Maryland law eliminates the application of any implied or

common law principles that are favorable to owners and would

control agreements governed by the laws in other states.

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Specifically, the Maryland statute changes the law of agency and

personal services contract for contracts governed by Maryland

law. The result is a dramatically different outcome: it enables

operators or brands to force owners to stay in an unhappy

relationship and to specifically perform their agreements.

This situation now means that when owners select their operator

or franchisor, one important selection criteria should be the state

law that the parties chose to govern their relationship.

The History Leading to Maryland's Law

The Maryland law was enacted in 2004 (Md. Code Ann., Com.

Law § 23-101 to 23-106 (West)) in response to a series of court

rulings favorable to owners, and unfavorable to hotel operators or

brands. The law was enacted to override the precedent of these

other owner-favorable cases.

The Maryland law was enacted,

[f]or the purpose of providing that if a conflict exists

between the express terms and conditions of an

operating agreement and the terms and conditions

implied by the law governing the relationship between a

principal and agent, the express terms and conditions of

the operating agreement shall govern; authorizing a

court to order a certain remedy notwithstanding the

existence of an agency relationship between the parties to

an operating agreement; providing that express

covenants or other provisions of an operating agreement

that establish a party's duties and obligations under the

operating agreement create the only duties and

obligations enforceable against the party under the

operating agreement; providing that an operating

agreement that states that it shall continue for a period of

time or until the happening of an event shall be

enforceable between the parties until the expiration of the

period of time or the happening of the event unless the

operating agreement contains a right of early

termination; requiring that the covenant of good faith

and fair dealing be implied in an operating agreement

except under certain circumstances; prohibiting duties

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from being implied into an operating agreement unless

the operating agreement contains a covenant or other

provision that specifically incorporates the duty into the

operating agreement; prohibiting this Act from being

construed to limit the defenses of fraud, duress, or

illegality or affect any claim between a third party and a

party to an operating agreement; defining certain terms;

requiring that this Act be construed to apply to all

operating agreements that are executory agreements as

of a certain date or are executed and delivered after a

certain date; and generally relating to operating

agreements that relate to hotels and retirement

communities.

(2004, Maryland Laws Ch. 292 (S.B. 603).)

While not directly identified in the 2004 legislative history, the

unfavorable "out-of-state court rulings" were likely references to

Woolley v. Embassy Suites, Inc. (1991) 227 Cal.App.3d 1520; Pacific

Landmark Hotel, Ltd. v. Marriott Hotels, Inc. (1993) 19 Cal.App.4th

615, and Government Guarantee Fund of Republic of Finland v. Hyatt

Corp. (3d Cir. 1996) 35 V.I. 483 —generally holding that based on

implied or common law principles, and despite provisions in the

hotel management agreement to the contrary, hotel operators are

agents of the owners and so the owners have the power to

terminate the operators at will, subject to having to pay damages

in the event that the owner lacked the contractual right to

terminate. The upshot of these cases had the effect of removing

the so-called operator's "death grip" on the hotel owner.

The Maryland Law Statutory Scheme

And so, in 2004, no doubt in reaction to strong pressure from hotel

brands with headquarters domiciled in Maryland

, the Maryland

Among other hotels operators headquartered in Maryland, are

Choice Hotels; Host Hotels & Resorts; Marriott International,

and the Ritz-Carlton Hotel Company. As of 2004, 11.1% of

Maryland's private sector was employed in the leisure and

hospitality sector. That grew to 13.05% as of 2019.

hotel.law/Maryland

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107

legislature passed a number of statues aimed at avoiding the

application of implied or common laws, to wit:

Md. Code Ann., Com. Law § 23-102 (West) provides, as

follows:

(a) If a conflict exists between the express terms and

conditions of an operating agreement and the terms and

conditions implied by the law governing the relationship

between a principal and agent, the express terms and

conditions of the operating agreement shall govern.

(b) A court may order the remedy of specific performance

for anticipatory or actual breach or attempted or actual

termination of an operating agreement notwithstanding

the existence of an agency relationship between the

parties to the operating agreement.

Md. Code Ann., Com. Law § 23-103 (West) provides, as

follows:

Express covenants or other provisions of an operating

agreement that establish a party's duties and obligations

under the operating agreement create the only duties and

obligations enforceable against the party under the

operating agreement.

Md. Code Ann., Com. Law § 23-104 (West) provides, as

follows:

If an operating agreement states that it shall continue for

a period of time or until the happening of an event, the

Included in the key words defined in the statute, Md. Code

Ann., Com. Law § 23-101, are the following:

(b) "Hotel" means a hotel or motel with more than 30 rooms

for rent that is primarily used by transients who are lodged

with or without meals.

agreement, instrument, or other document between at least

two persons that relates to the management, operation, or

franchise of a hotel or a retirement community.

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108

operating agreement shall be enforceable between the

parties until the expiration of the period of time or the

happening of the event unless the operating agreement

contains a right of early termination.

Md. Code Ann., Com. Law § 23-105 (West) provides, as

follows:

(a) The covenant of good faith and fair dealing shall be

implied in an operating agreement unless the operating

agreement states that a party may perform a duty or

obligation in the party's sole discretion.

(b) Unless an operating agreement contains a covenant or

other provision that specifically incorporates a duty into

the operating agreement, no duties shall be implied

under the operating agreement.

Case Comparisons Between the Maryland Law and

Other State Laws

To date, only one published case applying and analyzing the

Maryland Law has reached a court of appeal conclusion: IHG

Management (Maryland) LLC v. West 44th Street Hotel LLC (N.Y.

App. Div. 2018) 163 A.D.3d 413 ("44

Street"). In 2018, in a series

of three rulings, a trial court in New York applying the Maryland

Law found that it provided protection for hotel operators or

brands facing termination. The West 44

Street appeal court

reviewed and affirmed each of the three trial court rulings.

In the West 44

Street case, the owner of the InterContinental New

York Times Square Hotel, a $500 million property, hired IHG

pursuant to a 40-year term hotel management agreement that still

had another 30 years left on the term. The owner attempted to

terminate the agreement early based on its power and right to do

so grounded on the common law and alleged breaches by IHG.

IHG contended that the owner neither had the power nor the right

under Maryland law to terminate.

IHG sought a preliminary and permanent injunction to prevent

the owner from terminating the hotel management agreement

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and specific performance of the HMA to allow IHG to continue

operating the hotel.

Applying the Maryland law, the court issued a preliminary

injunction to prevent the owner's termination of the HMA until it

could be determined whether an event of default had occurred

(i.e., whether the owner had the contractual right to terminate the

HMA based on some uncured event of default). In granting IHG's

preliminary injunction preventing the owner's early ouster of

IHG, the court stated:

Most compelling to this Court is, however, if a

Preliminary Injunction is denied Plaintiff [IHG] will be

deprived of its contractual right (under Maryland Law)

to seek specific performance of the HMA. It is not

disputed if the Preliminary Injunction is not issued,

Defendants [owner] will follow through on their attempt

to terminate the HMA. Therefore, if Plaintiff [IHG] can

demonstrate it did not default, it will be unable to

retroactively return as manager to the property. The

necessary forfeiture of a contractual right outweighs

Defendants [owner] alleged harm in having to work with

Plaintiff for a few more months.

***

Plaintiff [IHG] argues if the injunction is not granted,

Plaintiff [IHG] will be deprived of its day in court. In

addition, Plaintiff [IHG] contends such a decision would

cause significant uncertainty with respect to hotel

management agreements that are governed by Maryland

law. Defendants [owner] argue they are being prohibited

from managing their own Hotel, and, if forced to

continue to employ Plaintiff [IHG] as manager, Owner

might default on its loan obligations. Defendants [owner]

claim their Owner's debt financing recently matured and

all refinancing options are at significantly less favorable

terms that may require debt payments in excess of the

Hotel's available cash flow.

While Defendants' [owner] complaints may have

credence, the Court is also cognizant that the Defendants

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110

[owner] voluntarily entered into a long-term

management agreement with Plaintiff [IHG]. To permit

Defendants [owner] to unilaterally terminate the

contract, in violation of Maryland law and without

establishing whether the grounds on which the

termination is based are valid, would unduly prejudice

Plaintiff [IHG].

(IHG Management (Maryland) LLC v. West 44th Street Hotel

LLC, 2018 WL 1730843, at *2 (N.Y.Sup.).)

As to IHG's claim for specific performance (i.e., that IHG could

force the owner to perform its obligations under the HMA and

keep IHG), the owner claimed based on common law principles

that the HMA was a personal services contract for which specific

performance was not an available remedy to IHG. Therefore, the

owner contended, it had the power to terminate the HMA. The

owner relied on Marriott Intern., Inc. v. Eden Roc, LLLP (N.Y. App.

Div. 2013) 104 A.D.3d 583, a seminal case finding that an HMA

was a personal services contract under New York law.

IHG contended that the parties agreed that the HMA was to be

governed by the Maryland law and that the Maryland law

specifically provided IHG performance as a remedy for an

anticipatory or actual breach or attempted or actual termination

of a HMA. As such, IHG argued that the holding of Eden Roc, a

New York case, was inapplicable to the subject case. Drawing on

the definition of "operating agreement" under Section § 23-101(c)

of the Maryland law, IHG argued that HMAs were specifically

contemplated by the Maryland legislature when enacting the

Maryland Law and, as such, HMAs are afforded its protection.

IHG argued that it is axiomatic that the Maryland legislature, fully

aware of other jurisdictions position on HMAs and the potential

for them to be found exempt from specific performance under the

common law, such as Eden Roc, took care to create a law that

prohibits that unilateral termination ability from hotel owners,

and that is likely why the term "operating agreement" was so

defined in § 23-101(c) of the Maryland law to remove any question

as to whether an HMA falls under the definition of "operating

agreement." (IHG Management (Maryland) LLC v. West 44th Street

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111

Hotel LLC, 2018 WL 1730840, at *2 (N.Y.Sup.).) The trial court, in

agreeing, with IHG stated;

Indeed, § 23-101(c) [of the Maryland Law] removes all

ambiguity from interpretation as to whether a hotel

management agreement may be specifically performed.

Maryland legislature has said yes. Section § 23-101(c)

defines operating agreement as a "written contract,

agreement, instrument, or other document between at

least two persons that relates to the management,

operation, or franchise of a hotel . . . ." Still, however, to

ensure Defendants personal service argument is aptly

dealt with, the Court will nevertheless address whether

this HMA is exempt from injunctive relief under Eden Roc

and similar cases.

(IHG Management (Maryland) LLC v. West 44th Street Hotel

LLC, 2018 WL 1730840 (N.Y.Sup.))

The trial court went on to additionally conclude that the language

in that HMA did not give rise to become a personal services

contract and therefore IHG could require that the owner

specifically perform the HMA. (IHG Management (Maryland) LLC

v. West 44th Street Hotel LLC, 2018 WL 1730840, at *1–2 (N.Y.Sup.).)

The West 44th Street appellate court affirmed all three of

the trial court's rulings and stated:

The court properly denied defendant owner's motion to

dismiss the cause of action for specific performance. It is

undisputed that the hotel management agreement

(HMA) at issue provides for the application of Maryland

law, which specifically provides that a court may order

specific performance for anticipatory or actual breach or

attempted or actual termination of a hotel management

agreement (Md. Code Ann., Com. Law § 23-102[b]; 23–

101[c]). Sections 14.02(d) and (e) of the HMA provide that

either party could seek specific performance, where

applicable. Defendant owner's argument that personal

service contracts such as the HMA cannot be specifically

enforced as a matter of constitutional and Maryland law

because such enforcement violates the Thirteenth

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112

Amendment's prohibition against involuntary servitude

is inapposite since, among other things, the owner

voluntarily negotiated for and signed the contract.

Moreover, the Maryland statute is presumed

constitutional and the presumption may be upset only by

proof persuasive beyond a reasonable doubt, which is

absent here [citation omitted].

(IHG Management (Maryland) LLC v. West 44th Street Hotel

LLC (N.Y. App. Div. 2018) 163 A.D.3d 413, 413–14.)

Contractual Choice of Law Provisions

Below are typical provisions in HMAs and franchise agreements

that would mandate the application of Maryland law, in lieu of

the implied or common law of other states, in an attempt to stop

an early termination of the agreement and an ouster of the

operator or brand:

Applicable Law. This Agreement is to be construed under

and governed by the laws of the State of Maryland

without regard to Maryland's conflict of laws provisions.

The terms of this survive the termination of this

Agreement.

Injunctive Relief. In all cases, either party may seek

injunctive or equitable relief, including restraining orders

and preliminary injunctions, in any court of competent

jurisdiction.

Because of the dramatic difference in results in the potential

outcome of an early termination or ouster based on implied or

common law, as opposed to the application of Maryland Law, an

owner should carefully consider the consequences of the law it

selects to govern the relationship with the potential operator or

brand. And, in the event of an impasse during negotiations as to

which law will govern, the owner might consider selecting a

different operator or brand that does not require Maryland law.

But, if there is no choice and owners is stuck with Maryland law,

then particular attention should be given to other provisions in

the agreement by sophisticated legal counsel who specialize in

such matters. As the power to terminate becomes less of an

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113

option, the right to terminate becomes more important, along

with creating agreements that demand accountability and

responsibility from operators.

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114

Epilogue

otel management and franchise agreements, and the

relationships between owners, managers and brands, is an

evolving world — the final chapters of this book remain to be

written.

JMBM's Global Hospitality Group® is committed to providing

hotel owners, developers, investors and lenders with resources

and programs that keep them informed of current issues and

trends in the industry, through the resources provided at

HotelLawyer.com, the Hotel Law Blog, Meet the Money®

National Hotel Finance and Investment Conference, our We Wrote

the Book series and our work in the field.

See www.HotelLawyer.com, www.HotelLawBlog.com and

www.MeetTheMoney.com.

But most of all, we want to hear from you. We are an enthusiastic

part of the fabric of the hotel industry and enjoy discussing what

matters to others in our world or about to join it.

So please contact us to discuss any of the issues raised in the

HMA & Franchise Agreement Handbook, or other topics that

concern you.

Jim Butler

[email protected]

310.201.3526

Bob Braun

[email protected]

310.785.5331

Mark S. Adams

[email protected]

949.623.7230

The HMA & Franchise Agreement Handbook

115

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