This edition's issue:

Matters relevant to new build hotels

During the course of a negotiation in relation to a hotel management agreement (HMA) there are many issues to be identified, negotiated and resolved. Some issues seem to come up more regularly than others and seem to take a disproportionate amount of time to deal with to the satisfaction of both owners and operators. In this series we will focus on a number of issues which fall into this category.

In previous editions of the newsletter in this series we have dealt with:

Hotel management agreements designed to deal with new build hotels usually raise issues and contain provisions which are not generally touched upon in management agreements that are largely designed to apply to an existing hotel property. These hotel management agreements need to cater for the multitude of issues which relate to all the steps of the construction process relating to the Hotel and the Operator's involvement and requirements in relation thereto. Documenting these issues in a comprehensive and logical manner can alleviate significant angst and potentially additional cost when the development gets underway.

Building a hotel throws up many curly issues as illustrated by the discussion below.

Since we are based in Australia, we will approach the issues below from a broadly Australian perspective. However, the good news is that we have 17 offices in Asia Pacific and many more around the world to answer any jurisdictional specific questions that may arise from the discussion below.

 

Issue

Discussion

Relevance of milestone dates

Usually, an Operator will agree not to manage another hotel with the same Brand as has been agreed upon for the subject hotel within a specified radius of the subject hotel. Primarily for this reason the Operator is keen to ensure that the hotel is constructed within a contemplated and time certain time line after the legal documents are signed. The nature of the relevant milestone dates are subject to negotiation but in our experience may include the following:

  • the date that financing has been approved;
  • the date that development approval has been obtained;
  • the date that construction of the hotel commences;
  • the date that practical completion of the hotel occurs; and
  • the opening date of the hotel.

Generally a grace period will apply to the milestone dates which can be three (3) to six (6) months after the date that the milestone event is estimated to occur.

If a milestone date is not achieved then usually the Operator has the right to terminate with or without the right to damages.

Relevance of Brand Standards and Brand Standard compliance

From an Operator's viewpoint it is critical that the hotel is constructed and fitted out consistent with its Brand Standards relevant to the Brand which has been selected for the hotel.

From an Owner's viewpoint, it wishes to ensure that its construction schedule and costs are not adversely affected by the requirement to comply with these Brand Standards and in particular, any changes to Brand Standards once construction is underway.

The legal documents need to contain a strict protocol to deal with these potentially conflicting objectives.

In general terms, the Operator should be given the opportunity to review plans and specifications in a timely manner and allowed to propose changes to ensure compliance and adherence with Brand Standards.

Once the Operator has been given the opportunity to provide comments then the construction should be able to proceed unhindered and specifically:

  • the Operator should not be entitled to propose material alterations once it has signed off on the plans and specifications, particularly where such alterations would lead to increased costs for the Owner; and
  • the fact that Brand Standards change during the construction process should not be allowed to unduly impact on the development.

To facilitate this process it is usual for a Project Control Group (PCG) to be established with representatives of the Owner and Operator. The PCG generally meets monthly or at other regular intervals to review the progress of the construction process and to put in place a procedure for orderly review of such process by the Operator.

Prototype hotel room

An important and usual part of Brand Standard compliance is the requirement on the part of the Owner to fitout a mock up of a typical hotel room no later than a specified date before the anticipated date for practical completion. The Operator will be entitled to inspect the prototype hotel room and make suggestions for changes.

Obviously detailed consideration needs to be given to the scope and nature of the discretion that the Operator has to propose changes. It is also critical to ensure that this process does not adversely impact the construction and fitout schedule of the hotel.

Hotel opening date - Operator approval

The date when the hotel is ready to be opened for business to the public is usually determined by reference to satisfaction of a number of specified requirements including:

  • Owner's project manager or superintendent has certified that the hotel has been completed in accordance with the plans and specifications approved by the Operator
  • all relevant approvals and authorisations have been obtained for the use and occupation of the hotel including relevant Fire Life Safety Standards and a relevant liquor licence has issued (if applicable);
  • all relevant insurance has been obtained;
  • all hotel personnel have received sufficient training to permit operation of the hotel consistent with the Brand Standards; and
  • construction of the hotel (including installation of all the FF&E) is complete.

Usually the most contentious of these requirements is the last. Owners are usually keen to open as soon as possible and so an Owner may wish to press the Operator to agree to open the hotel when the hotel is substantially complete but not totally complete. For example, FF&E installation for a small number of rooms may be delayed and the Owner wishes to open the remainder of the hotel. In these circumstances the Owner and Operator would usually negotiate whether the hotel can be formally opened under such circumstances and in which event a timetable would usually be agreed with respect to the installation of the remainder of the FF&E and the remedying of any potential defects relevant to such installation.

If an Operator has provided any performance guarantees which are scheduled to commence at or about the opening date of the hotel, the Operator may wish to discuss how opening the hotel when it is only substantially complete may impact on these guarantees. The Operator may propose to either reduce the guarantee amount or defer the commencement date for the guarantees.

Operator contributions

The Operator may agree to make a financial contribution as part of its commercial proposal to manage the hotel.

If this financial contribution is designed to be an upfront payment then usually it is only payable once the hotel is open for business.

This can become complicated if the parties agree to open the hotel notwithstanding all of the matters referred to in the previous paragraph have not been fully completed.

In such circumstances the Operator may wish to defer the payment obligation until all relevant matters have been fully completed. If this is the case then the Owner needs to ensure that such deferral does not create any issues or complications with respect to any other third party financing commitments.

Owner financing construction of new build hotel

This can be a tricky issue for a new build hotel particularly if it is part of a mixed use development.

Usually the hotel management agreement is negotiated prior to the financier being identified and the terms of the financing agreed. Accordingly it is important for the Owner to ensure that any financing requirements imposed by the Operator are sufficiently flexible to ensure that the Owner is not prevented from obtaining finance on the best possible terms.

Separately, Operators usually prefer financing to be hotel specific. If the hotel forms part of a larger mixed use development then usually construction finance is obtained for the development as a whole. In such circumstances Operators will usually require that the financing becomes hotel specific as soon as possible after the hotel opens to the public.

This requirement will usually be accompanied by a requirement for a non disturbance agreement between the Operator, Owner and financier particularly if there are Operator contributions which are refundable either in whole or in part.

FF&E procurement

An Operator may be prepared to procure FF&E on behalf of the Owner. Operators prefer to do this as it gives the Operator greater control over the process of procurement and also gives the Operator greater satisfaction that the FF&E items obtained are consistent with Brand Standards. Some Owners are wary of this as there is a degree of concern that FF&E items procured by the Operator may be more expensive than if such items were procured by the Owner. From an Operator's perspective, however, it considers that it is generally able to procure FF&E items at a cheaper rate given its ongoing relationship with suppliers.

FF&E purchase and installation by Operator

The deal between the parties may be struck on the basis that the FF&E items are procured by the Operator without reimbursement from the Owner. In such circumstances the Operator usually has an obligation to install such FF&E items in the hotel. Installation usually takes place either shortly before or shortly after practical completion of the hotel. At such time arrangements need to be in place to ensure that the Owner's builder is required to give the Operator reasonable access to the hotel to effect installation. The hotel management agreement should contain detailed provisions dealing with matters including:

  • when the Operator's works are to be undertaken and the manner in which such work needs to be undertaken;
  • access to enable the work to be undertaken;
  • relationship between the Operator's builder and the Owner's builder;
  • nature and extent of any relevant defects liability period; and
  • obligations to rectify any damage caused or contributed to by the Operator.

Common facilities

If the hotel forms part of a mixed use development then there may be a number of facilities or amenities that the hotel shares with other components of the development. Examples include common access ways, car parks, swimming pool and gymnasium.

It is important that the hotel management agreement addresses each of these issues and creates a protocol as to how each will be dealt with.

For example, in the case of a swimming pool which is available for use by hotel guests and occupants of residential apartments which also form part of the development, typical issues include:

  • should the swimming pool be located on the hotel lot or the residential lot or form part of common property;
  • if located on the hotel lot, what controls are placed on use by residential occupants to ensure that over crowding does not occur;
  • what rules and regulations can be put in place to ensure that any user exhibiting significant rowdiness or anti-social conduct can be properly dealt with; and
  • how should the cost of maintaining the swimming pool be fairly and equitably apportioned between all users.

In these circumstances the hotel management agreement should be drafted in a manner to ensure that the obligations contained therein (particularly with respect to the Owner) are not capable of conflicting with the limitations contained in relevant title documents and other laws making compliance with such obligations difficult or impossible.

Rules and regulations

A further issue with mixed use developments is the scope for imposing restrictions on other components of the development which are considered to be adverse to the optimal operation of the hotel.

If the development also comprises a residential development then there is generally a desire to ensure that residential apartments cannot be used to conduct a short term letting operation either individually or by pooling together a number of such residential apartments.

If the development also comprises a retail component then there may be a desire to prescribe what kinds of retail activities can and cannot be conducted with the aim of ensuring that such retail activities enhance the customer experience that the hotel is seeking to engender.

These issues can throw up complex legal issues which need to be resolved to the satisfaction of both Operator and Owner before the project can proceed.

Detail

To avoid disputes and, potentially, additional expense, the hotel management agreement should as far as possible contain sufficient details of any relevant obligation. Examples include:

  • if there is an obligation that the hotel has suitable external signage featuring the Operator's brand, then sufficient details of the location of such signage and other relevant details should be annexed to the agreement;
  • if there is an obligation on the part of the Operator to make a financial contribution which is intended to be used to finance the acquisition of specified items, then such items should be referred to with the agreement and as much detail as is reasonably possible in respect of such items should be provided; and
  • if the Operator is to provide technical services then the specifics of such service should be itemised.

 


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