Tips For Negotiating Hotel Management Contracts

The economic challenges of the millennium have brought about significant changes in the way businesses operate. As an example, hotel management contracts continue to evolve. In this changing climate, what do hotel owners need to know about negotiating the most effective management contracts?

“What’s happened over the last 15 or 20 years, with the emergence of limited-service and select-service hotels, [is that] there are a lot more players in the industry than there have been historically, and many of these owners — many on their first hotels — want to look for management services. But inevitably, when they open a second or third hotel, they want to manage their own properties,” says Glenn Squires, CEO of Pacrim Hospitality Services Inc.

The resulting competition for business favours the hotel owner. A decade or two ago, major hotel brands were able to set a fairly rigid contractual standard. “In those older agreements, basically you as an owner gave up the full responsibility of running the hotel to the brand. You had very little oversight and [not] much input with the management company as to how the business was being run,” says Philippe Gadbois, senior vice-president, Operations for Atlific Hotels Inc.

“What has evolved over time is the advent of third-party management companies. In today’s world, the third-party manager uses the brand for [elements such as reservation feed and quality standards], but is responsible for the day-to-day management of the hotel itself. The third-parties are more flexible — read ‘less expensive’ — than the big brands,” he says. “For instance, when it comes to the compensation of general managers, says Gadbois, “big brands will create a structure wherein all [its branded hotels] have some form of correlation with each other. An independent management company does not have to be governed by that.”

“For the most part, you’ve got assets that cost more to run, to staff, to build and to keep up, and the incremental revenue has to be commensurate with the cost increase, so you’re trying to find ways to be as efficient and as profitable as possible on behalf of an owner,” says Tony Cohen, executive vice-president and partner, Canada with Crescent Hotels & Resorts. “There has been an evolution in the way contracts are structured in order to give the best benefit and the best flexibility.”

At one time, owners could be tied into management contracts for decades and an early exit could be costly. This is one of the areas that has loosened up considerably. For instance, Crescent Hotels & Resorts offers termination with no punitive damages. “Our contracts are typical five-year with a five-year option,” says Cohen, adding that “We’ve run probably 500 hotels in our career and only less than five times have owners exercised that termination [right].”

At Pacrim Hospitality Services, Squires says, “generally we want a long-term contract with top termination language, except for cause. We’re more likely to do it with an institutional investor or, if it’s an individual owner, someone who’s arms-length. We will want to take an equity investment, because then you’re looked at [as being] on the same side as the owners. We have to get our equity out at fair market value, which makes an exit more difficult.”

But Gadbois points out there is no such thing as a one-size-fits-all management contract, because different owners have different objectives. “For some owners, it is as important to maintain the local standing of a hotel in their city as it is to deliver a few extra dollars to the bottom line. The biggest issue of discussion, strangely, is not day-to-day operation; it’s reinvestment in the hotel. The theory is that managing one hotel is the same as managing another; it isn’t, and you need that flexibility.” “Another place contracts have been more flexible, which is, of course, of benefit to the owner, is fees,” says Cohen. He cites the example of “structuring a deal that’s more conducive to an owner making more money — so maybe lower fees with greater incentives. In our case, we don’t charge any additional fee or incremental percentage on any flow-through benefits, so [with] any efficiency we provide, all that benefit goes to the owner. We don’t charge on that.”

For the owner negotiating an advantageous contract, “the most effective way is [to] have performance language in the management agreement and to have regular methods of reporting and communication with the management firm, either directly or with a senior representative,” says Squires. He recommends careful wording of performance language. “You generally want the hotel to hit a threshold on market share against its competitors and a financial target that is tied to past performance and market conditions.”

But beyond specific clauses or wording, the single most critical element in negotiating the right management contract lies in communicating the owner’s goals and objectives and arriving at a position of harmonious alignment between owner and manager.

“Very simply put, if the owner and the management can get to a point where their interests are aligned, or really understood, and both parties work together co-operatively to get to the objective, then it’s pretty simple,” says Gabois. “Ultimately, we work for the owner; our only responsibility is working for the owner.”

The best contract is “whatever creates the most alignment and the best opportunity to perform on behalf of an ownership group; whatever you can do in terms of structure, oversights, chargebacks, termination to ensure that you as an operator can do the job,” says Cohen. “You’ve got to create alignment. Contracts where there are heavy termination fees or a lot of restrictions on the owner don’t create alignment. Those create, to a certain extent, conflict. We’ve tried to eliminate any of those potential conflicts,” he says. “Effectively, as an operator, we are an employee of the owner and our contract, to a certain extent, is an employee contract. We are very owner-friendly, because that’s our lifeblood.”

Volume 39, Number 3
Written by Saran B. Hood