Hotel Management Contracts:

Key Issues to Consider While Negotiation

Because of the booming hospitality industry in Ethiopia and the ever-increasing awareness of hotel owners about management contracts, hotel management by brand-affiliated operators is fast increasing. These contracts grant operational control of a brand – in this case, an international brand hotel chain – to a management company, usually based in the country of operation, in exchange for a fee.In consideration of this fact, the government has issued a basic regulatory framework of franchising to fill the gap in the absence of a detailed franchise law.One of the concerns of hotel owners is to know what issues to consider while negotiating and signing hotel management contracts (HMC).The following are a few of the key issues and provisions to consider when entering a HMC. These will help ensure fair, equitable relations between large hotel chains and local investors, thereby helping grow the private sector:

Selection of a brand
The selection of a brand should be based on research and analysis on the background of each operator relating to their management success, good will, financial standing and related issues. The brand chosen directly affects the level of services and amenities offered, the hotel’s price point, competitive set, cost of development or conversion, and cost of operation. Accordingly, owners are advised to pursue several branding options not to limit the pool of suitable operators.

Negotiating the contract
Issues to be covered as subjects of the contract may range from involving the operator in the design and construction of the hotel to starting the operation after the hotel is ready for service. All these depend on the choice of the owner. So far, concrete statistics are not available in Ethiopia as to how many operators are involved starting from the design stage and how many of them take over the management after the hotels are ready for services.

Negotiating the financial aspect
Management fee structure, reimbursable expenses of the operator, operator loan or equity contributions (terms and conditions, priority, and payback) are some of the most important elements of the contract to negotiate and settle. Furthermore, there are several add−on fees associated with HMC that do not appear in the base fee, such as incentive fees, mandatory contributions to sales and marketing funds, and accounting fees, to name only a few.
HMC are most often based on total revenue. Most of the brands use standard contract terms and conditions with minimum flexibility tolerance adoptable to each client’s specific legal system. Therefore, securing discount less than their standard offer may not be easily possible. Keeping on the bargaining until the last minute of signing the contract should be the rule of the game.

The non-financial aspects of the deal
There are numerous provisions and conditions essential to a well-crafted HMC, and the list has grown with the dynamics in the industry. The provisions and conditions include termination clauses, compensation for unfair termination, operator performance standards, owner input in operational decision−making, and operational and financial reporting, among other things.

Of course, the provisions considered key to a given contract will vary with the owner’s objectives, the requirements of the deal (e.g., operator financial participation or not), the dynamics of the negotiation, and other circumstances of the project. Based on these considerations, it is worthy to note some of the key provisions and conditions from the owners during negotiations.

Approval right on plans and management of personnel
Owners should have the right to approve and review a detailed annual operating plan with the operating budget and business plan inclusive of the marketing plan according to a pre−determined schedule. Similarly, owners should insist on the right to review and approve the annual capital expenditure plan. It is critical that owners maintain control of how the reserve for replacement fund is spent to ensure that capital projects enhance asset value rather than satisfying brand standards without commensurate economic return for ownership. Further, owners should seek approval rights over the key executives hired to operate the hotel and should retain the right to remove any member of the executive committee should there be sufficient cause to do that.

Periodic meeting and access to documents
The owner has to meet with the operator periodically to review the financial performance of the hotel. Right to have access to and audit the books and records of the hotel should also be another important concern of the owner. This right allows owners and their representative’s full access to all records and explicit permission to conduct an audit of the hotel’s financial and accounting practices at the owner’s discretion. This kind of right will enable the owner to know if the financial operation of the hotel is in compliance of the tax laws and avoid tax crime liabilities.

Termination clause
Owners should pursue the right to terminate in the event the operator fails to perform to an acceptable level, defaults on a substantive provision, or breaches its fiduciary duty to the owner. The right to terminate upon sale is also an important option that can be critical to owners seeking a short−term exit strategy. When dealing with branded operators, however, owners can expect significant resistance to early termination on sale and should be prepared to pay liquidated damages to exercise this right. If the hotel is a new development, words should also be included specifying the owner’s right to terminate should the project be sold before opening or, alternatively fail to open. Procedures on early termination should also be meticulously defined in the contract.

Dispute settlement and governing law
The owner should choose the jurisdiction and governing law for dispute settlement by court or arbitration institution based on convenience, cost effectiveness and other related criteria. Even though Ethiopia is the best jurisdiction for the owner and Ethiopian is preferred by owner to be the governing law, the operator may not agree on these for reasons of lack of confidence on the court and arbitration tribunals in Ethiopia. Therefore, the usual trend is to agree on the dispute settlement to be made in a jurisdiction other than Ethiopia and Ethiopian law.

5th Year • January 16 2017 – February 15 2017 • No. 47