Management Agreement Turmoil A Word to the Wise: Disclosure
 
October 21, 2002
 
James M. "Jim" Norman- Ft Lauderdale

These are good days for lawyers involved in prosecuting or defending claims by hotel owners against brand managers operating independently owned hotels with the manager's flag.  First it was the Woodley Road case involving Sheraton, and then several recently filed cases involving Marriott International, Inc. and its purchasing affiliate, Avendra LLC.  Depending upon the outcome of these cases, and even more likely, during their pendency, it is reasonable to expect a fair to considerable number of similar cases filed against other brand managers throughout the industry.  The two recent major cases, were filed by CTF Hotel Holdings, Inc. (April 12, 2002) and Strategic Hotel Capital, LLC, through two affiliates (August 20, 2002).

The CTF case also includes Avendra.  Avendra is owned by a number of hotel companies, including Marriott, Hyatt, Six Continents, Fairmont and Club Corp. USA.  Other hotel companies purchase through Avendra as well.  Avendra bills itself as the largest procurement service company serving the hospitality industry in North America and the Caribbean. 

Depending on your point of view, the owner versus operator cases are about (i) terminating a long-term management agreement without penalty because of the economic performance of the hotel under the management of the operator or (ii) a breach of the fiduciary relationship between the owner and operator arising by virtue of the exclusive agency given to the operator by the owner in the management agreement.  The CTF and SHC complaints are very lengthy and allege a wide variety of violations of contractual, statutory and common law legal principles.  The essence of the allegations, however, is that the operator, sometimes acting through Avendra or other subsidiaries, affiliates or third parties, accepted (again depending on your point of view) kickbacks, commissions, or what have been termed "sponsorship funds."  The owners allege that as fiduciaries, the operators are obligated to return these monies to the property because of the fiduciary nature of the relationship. 

For the benefit of non-lawyers, a fiduciary is one who acts primarily for the benefit of someone else in connection with a specific undertaking.  Inherent in the relationship is the highest standard of duty with respect to trust, confidence, scrupulous good faith and candor.  The fiduciary is not permitted to take advantage of the principal for his own benefit.  A perennial  topic of heated negotiation in management agreements is that of the specific legal relationship between owner and operator, and specifically whether a fiduciary relationship is created or is waived to the extent the law allows.  Operators prefer to limit the description of the relationship to that of independent contractor, and owners want to specifically define the relationship as fiduciary and principal.  In most jurisdictions, what it is called does not matter; the terms of the agreement and the responsibilities undertaken by the operator as the owner's exclusive agent in dealing with the hotel are the elements that matter.  If one or more of the currently pending cases ultimately become the subject of a published appellate opinion, there likely will be considerable discussion of the nature and extent of the fiduciary relationship in the context of a hotel management agreement by the court.

What Should Owners and Operators Do in the Meantime?

A reading of the CTF and SHC complaints (and the answers as they are filed by the defendants) provides a blueprint of the areas of disagreement and the actions of the parties that have generated a basis for the claims.  Reading between the lines, the essential complaint by owners is that "you didn't tell us that you were going to receive money from vendors and we never agreed that you could keep those funds."  This is, of course, an oversimplification, but does capture the crux of what this litigation is about. 

In negotiating a new management agreement (or amending an existing one) the obvious answer is for the owner to demand a disclosure of transactions between the operator and its affiliates and other situations where some commission, sponsorship or other similar payment is to be made to, and retained by, the operator.  The disclosure also should be part of a management agreement provision that specifically authorizes, prohibits or requires the sharing of these monies as between the owner and operator.  The more specific the provisions of the management agreement relating to purchasing or any potentially contentious topic, the less likely a dispute or claim.  Both parties will know up front what they can do, what they can keep or what must be returned to the property.  Management agreements may specifically provide that an owner has the right to "opt out" of any or all purchasing programs, or that the operator has free rein to deal with purchasing, so long as it is obtaining the best price for the hotel.  Complete and detailed disclosure prevents disagreements, misunderstandings and claims.  It may also prevent a long-term management agreement becoming a short-term management agreement.  It is likely that because of the pending litigation, purchasing programs and the operator's authority will become the subject of very detailed contract provisions, similar to those dealing with the annual budget.

Negotiating a more detailed management agreement is always a challenge. What about the thousands of management agreements already in place?  Is there anything that can be done by owners and operators to minimize the kinds of disputes that are now being litigated?  Clearly there are.  The first step is a careful review of existing agreements.  What is contemplated with respect to purchasing?  The agreement may have been executed a number of years ago.  What has been the conduct of the parties?  Are the terms of the agreement even being followed? 

An assessment by owners and operators of existing management agreements will determine only what was contractually required.  There is nothing wrong, and in the current climate, indeed advisable, for operators to consider providing more information, more disclosure and more detail to owners.  That will either elicit questions, or, in many jurisdictions, create a situation where the owner has effectively consented to the current practices. 

Because of the strong likelihood that the operator will be deemed the fiduciary of the owner, whether required or not, full disclosure of all items related to the operation of the hotel should be provided to owners.  This information should be provided on a regular basis, and a likely time and place to do so is with the periodic accounting reports that are provided for each individual hotel property.  Does disclosure pose a risk to operators?  Certainly, but there are rewards as well.  The risk, however, is more likely to be that of having to pay or share monies received from affiliates or third parties.  The disclosure itself can yield rewards because it makes it less likely that claims for punitive damages and allegations of violation of federal and state racketeering and antitrust laws can be successfully maintained.  It is also far more likely to bring about a dialogue that may result in a modification of the management agreement to specifically deal with these issues.  That, in turn, handled appropriately, can reduce the potential for a termination of the management agreement based on a breach of fiduciary duty.  This result is a clear reward to the operator.

This article has attempted to simplify some of the legal and business issues facing the hospitality industry with respect to management agreements.  These documents are not, however, inherently simple, and it is vital that the terms of the management agreement, the ongoing operation of the hotel, and the communications between owner and manager be handled by people with a thorough understanding of these issues and their complexities.  The hospitality industry currently has sufficient economic challenges.  Every effort should be made to avoid the distractions inherent in protracted and expensive litigation.

For more information, e-mail Jim Norman at jim.norman@hklaw.com, or call toll free, 1-888-688-8500.