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Hospitality Matters - Hotel agreements

Posted on 21 April 2021

Whilst UK hotels are excitedly working on their reopening plans, and some have started welcoming guests for outside food and drink, most will also still be counting the costs of the COVID-19 pandemic. The pandemic, and the Government's response to it, brought hospitality to a standstill, with plummeting or non-existent occupancy rates, room and food revenues. In our previous article, we touched on how, throughout the pandemic, most hotels faced fixed costs that they could not mitigate. Some may no longer be viable or attractive to be operated as hotels, which may mean moving into a different asset class or taking other drastic actions.

Whilst we expect hotel assets to bounce back, we are already seeing signs of increased activity as some owners seek to divest certain assets and others look to pick them up. Now, perhaps more than ever, it is important for those involved in the sector to understand the implications of any actions that they are thinking about taking and therefore to understand the rights and obligations under existing hotel agreements and the options that may exist within them. Others may simply need to revisit and revise their models in light of their pandemic experiences.

In this article we consider some of the implications for owners, brands, operators and prospective buyers when an owner looks to sell a hotel, change its usage or brand, or otherwise bring an end to a franchise or management agreement.

A) Owners

Owners looking to sell a branded hotel without the brand, to change brand or operator or to change hotel usage:

  • This undoubtedly presents challenges. Franchise and operating agreements rarely include provisions entitling any party to terminate for convenience; so any attempt by an owner to unilaterally terminate a hotel agreement may therefore be a breach of contract. Such a breach can allow a brand/operator to terminate for the owner’s repudiatory breach and to recover damages for breach of contract. Given that franchise and operating agreements are usually long-term arrangements, such damages will likely be high (see section E below.)
  • However, some agreements do include provisions that provide the owner with a right to terminate by paying an exit fee. These are often calculated based on a multiple of the previous 12 months gross revenue. As revenues have been at historic lows for the past 12 months, for some, there could be a golden opportunity to get out of agreements, to change operator/brands or to use the possibility of termination to secure changes. Again, owners will need to take particular care to ensure that such provisions are applicable and they comply with them. Any sums may also be payable within a short timescale so owners will need to ensure they have sufficient funds in place.
  • When exercising any termination right it is important to follow any procedures in the agreement but also to consider what other risks you may face, such as for your own non-compliance, as mistakes on both counts can prove costly.
  • Owners of multiple branded hotels may seek to leverage any ongoing relationship with the brand to try to cut a deal in respect of one or two hotels. If a hotel owner is looking to divest or change all or a large number of hotels this will be likely to prove more challenging. However, if there is a genuine prospect of insolvency if a deal is not done, owners may seek to use that (and the risk that the brand/operator may lose the ability to enforce any claim or end up joining a queue of unsecured creditors) to try to persuade the brand to agree to accept a lesser sum, to obtain a clean break.

Owners looking to sell hotels under their current brand:

  • Hotel franchise and operating agreements usually prescribe the procedure for any transfer of ownership. These provisions can be detailed, complex and onerous, and sometimes exclude certain classes of buyers and/or may provide additional rights to the brand/operator.
  • Owners will need to check and follow the applicable provisions and, whilst needing to comply with any such provisions, will also want to time carefully any disclosures to the brand/operating company (and qualifying buyers will need to sign up to the agreement with the brand/operator).
B) Brands
  • If an owner is looking to sell with your brand: The impact of the pandemic on the sector perhaps means that brands may now, more than ever, need to take a close eye on the bona fides and viability of any prospective purchaser of the hotel.
  • If an owner terminates:
    • Brands have a careful balancing act: on the one hand they will want to be adequately and fairly compensated by any owner that wishes to terminate early; but, on the other, they need to manage and protect their reputations with existing and prospective owners and customers.
    • If the agreement with the owner includes provisions allowing the owner to terminate and managing such a process, then the brand will want to make sure that the owner follows them carefully. Contracts do not always include adequate provisions detailing what happens on a termination so, in addition to the myriad financial implications, amongst other things, a brand will need to ensure that it manages carefully the debranding of the hotel; handles customer bookings, communications and data; controls and recovers its data, confidential information, property, software and equipment; updates its websites, social media accounts, bookings systems, loyalty programs and so on. Agreeing and implementing an effective exit management plan may be a time consuming process.
    • If the agreement does not allow the owner to terminate then, as mentioned above, this will be a breach of contract and the considerations set out in Section E below will apply.
C) Buyers planning to change the use of a hotel
  • Potential buyers, especially those interested in repositioning an existing hotel, for example to residential or student accommodation, will also need to be alive to the possible implications of existing agreements and the cost of removing themselves from them. Such buyers will also need to consider the wider implications of repositioning the hotel, such as on staff, whether any construction or re-development works are required and in respect of the contracts the hotel has with other parties. It will be far easier to leave the seller to resolve some or all of these issues as a condition of any purchase.
D) Operators
  • Operators are likely to have many of the same concerns and considerations as brands as set out in B above. Operators, like brands, will want to be compensated by any owner that wishes to terminate early in breach of contract and so the considerations set out in Section E below will apply also to an operator that is terminated by an owner who does not have the right to do so. Whilst many owners are the employer of hotel staff, operators will still need to consider the effect of any termination on hotel staff and any staff it has engaged in the hotel operations. The hotel's trading and operating agreements should all be in the hotel’s name so, provided that this is the case, should not be the operator’s concern, albeit they may have reputational or other impact on the operator.
  • Operators, blighted by a year of inactivity and low or no income, may also be revisiting their template agreements to ensure they provide better protection against uncertainties be it by reviewing force majeure provisions or seeking to include minimum and other payments so they have some costs coverage if disaster hits again. Any that take on the responsibility for any hotel employees may also be rethinking their models.
  • Brands and operators will also want to keep an eye on owners’ finances to ensure that sufficient sums will be made available for operating costs, FF&E and so on.
E) What happens if a contract is terminated unilaterally without a contractual right to do so?

If an owner indicates that it wishes to terminate the agreement and does not have the right to do so, this is very likely to be a repudiatory breach of contract. This will provide the brand/operator the right to terminate the agreement and, unless the contract fixes the damages payable from such a breach, to seek the profit it would have made under the agreement from termination until the date the agreement should have ended. It is quite possible, therefore, that the brand/operator will accept the termination and seek damages from the owner. However, they could determine to continue the contract, if it is practicable for them to do so and they can continue without the owner’s cooperation, which might be possible if they are in control of all aspects of the hotel.

If the brand/operator accepts the repudiation, the contract will come to an end and the brand/operator will likely seek damages from the owner. Damages put the brand/operator in the position it would have been in had the contract been properly performed and will be subject to the usual rules governing the recovery of damages (causation, remoteness and mitigation). The brand/operator is required to mitigate its loss (i.e. to avoid or reduce it) although the owner has the burden of proving the brand/owner did not mitigate and, in practice, it might be difficult to see how a brand or operator could mitigate immediately if an owner ends the contract early. Clearly, over time, it might find a replacement franchisee or hotel to operate. However, the current negative market conditions may make it more difficult to determine in what period the brand/operator might be expected to have mitigated its loss and found an alternative source of revenue. Quantification of damages for breach of contract is fact specific and, provided the requirements on causation and foreseeability are met, damages might not be limited to the sums that would have otherwise been due under the contract, if it had been performed. For example, loss of an opportunity may potentially be recoverable in certain circumstances.

If you'd like to discuss any matters relating to this article or the Hotel industry please contact Lewis Cohen or a member of our Hotels Group.

This is the second in a series of Hospitality Matters articles dedicated to issues and opportunities facing individuals and businesses in the hospitality industry today. Click here to be added to our mailing list for future articles.

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