Hotel Management Agreement Disputes Litigation vs. Arbitration
 
February 19, 2008
 
Richard C. "Rick" Hutchison- West Palm Beach
James M. "Jim" Norman- Ft Lauderdale

When it comes to choosing a method for resolving hotel management agreement disputes, hotel owners and operators might be compared to beer drinkers. One side wants a beer that’s “less filling” and the other side wants a brew that “tastes great.” In negotiating the dispute resolution provisions of hotel management agreements, owners generally prefer litigation while operators typically want arbitration. The result of this disagreement is often protracted negotiations over one small part of the hotel management agreement. It’s often left “to the lawyers” and that doesn’t resolve the issue as both points of view are legitimate.

Protracted Disputes Damage Relationships

It’s worth noting that with respect to operational disputes, such as resolution of the annual budget or determining the performance test competitive set, both sides now most often agree to have an industry expert resolve these disputes on an expedited basis. This serves to protect the owner/operator relationship from the damage caused by protracted disputes. The real challenge comes when the nature of the dispute is one that will or could result in a termination of the management agreement, most often accompanied by a loss of the brand. The one area of general agreement is that the parties will agree to an initial non-binding mediation of the dispute, but when it comes to final resolution of the dispute, we’re back to owners wanting litigation and operators insisting on arbitration.

Why is it that owners by and large want these termination disputes handled in court, and preferably by a jury? The answer: hospitality industry litigation over the last decade or so has largely favored owners.

In at least one case, 2660 Woodley Road Joint Venture v. ITT Sheraton Corp., 369 F.3d 732 (3d Cir. 2004), a jury was persuaded to award millions of dollars in punitive damages. While most of that reward was reversed, it did result in a tendency for operators to try to avoid juries. This, in turn, led to management agreement contract language that mutually waived the right to trial by jury and punitive damage awards. Operator form document language now customarily prescribes that all disputes (often yielding to the expert process for operational matters) are to be resolved through binding arbitration. The nature of the arbitration procedure significantly eliminates the ability of either party to appeal the arbitrators’ decision and award, absent corruption, fraud or undue means. Owners, on the other hand, based on the outcome of Woodley Road and its progeny, simply prefer their perceived odds of success at the courthouse. How then to best resolve this inherent disagreement on the nature of the dispute resolution process?

The Arbitration Process: Different Views

Many people, including most transactional lawyers, believe that arbitration is an informal, quick and relatively inexpensive process that gets to the same place – but with much less pain and legal fees. Others point out that the ultimate cost is comparable and decry the loss of the due process rights that are inherent in the litigation process through, for example, rules of civil procedure. Many believe, and in some cases fear, that the arbitration process does not do justice to complex matters. As the old saying goes, “All generalizations are false, and that’s a generalization.” Moreover, critics of arbitration bemoan its lack of any substantive review of the outcome, barring fraud, corruption and undue means.

The truth is that sometimes arbitration works as intended, and sometimes, it can take as long and be at least as expensive (as well as outcome disappointing) as litigation. It is difficult to have, unlike most trials, a lengthy arbitration hearing begin and proceed without interruption to completion. The schedules of the members of the arbitration panel, for example, might only allow a few days at a time, and the various sessions might be months apart, thereby requiring the time and expense of getting everyone back “up to speed” in the case.

The solution, and one which many people do not realize, is that the specifics of an arbitration process can be negotiated and documented in a way that gives both those who favor litigation and those who favor arbitration most of the core elements that they view as essential.

Are Arbitrators Really Neutral?

Those who are concerned that despite contract provisions relating to the qualification of members of the arbitration panel, the neutral arbitrator will wind up having some allegiance to the other party, such as a prior relationship (or potential future one), or a shared point of view on some significant issue. Thus, the limitations on the right of appeal alone frequently makes arbitration an unacceptable alternative to litigation. Lawyers are frequently concerned that arbitration, by virtue of the whim of the panel, has either wide open discovery or overly limited rights of discovery which operate in a particular case to disadvantage their clients. Similar concerns exist with respect to the arbitrators’ application of the rules of evidence or the applicable substantive law. Again, all of these items are, contrary to common practice, subject to negotiation and the drafting of contract provisions that will protect the legitimate interests and concerns of both sides.

How to Make Both Sides Happy

What then is the best approach to giving the side favoring litigation what it wants while providing the side that prefers arbitration with the speedy and final resolution out of the public eye that it wants? Most simply put, it is through adding:

• provisions relating to discovery
• timeframes for completion
• rights of appeal to the arbitration process

By the same token, the jurisdictional limits imposed on courts require that adding these elements to the arbitration process must be done by counsel with considerable knowledge and experience in this area in order to avoid a situation where a court will not recognize certain rights that the parties have agreed by contract to add to the arbitration process. Indeed, there is a split in the federal circuit courts as to whether parties can contractually expand the judicial review grounds in the Federal Arbitration Act. The United States Supreme Court, however, is currently considering a case that involves that issue. Oral argument was in November 2007 and an opinion hopefully resolving that question should be forthcoming.

New York Law and Venue

New York law and a New York venue for dispute resolution proceedings are those most commonly seen in hotel management agreements. This utilization of New York law and venue is a practical one, as New York has a very evolved body of commercial case law, and the availability of many highly qualified arbitrators. Counsel on both sides of the industry table are generally familiar with New York law and the major hospitality dispute cases, but are not familiar with the law in many other jurisdictions, including smaller states in the U.S. and foreign jurisdictions. New York law, however, imposes certain limitations with regard to expanding the judicial review of arbitration proceedings. Hence, counsel should proceed with caution when drafting such provisions. Fallback provisions are sometimes necessary.

Once the “best of” arbitration and litigation reaches the point of conceptual agreement between the parties and their counsel, there is a level of detail that must be included in the dispute resolution provision in order that those conceptual rights become available in practical terms to the parties and their counsel.

Long-Term Relationships Defined by Long-Term Agreements

The ultimate goal of any dispute resolution process should be to provide to each of the parties the rights and remedies that they bargained for in the hotel management agreement. Since most hotel management agreements are very long-term agreements, the importance of the dispute resolution process cannot be over emphasized.
Of course, the best dispute resolution process is dispute avoidance. That’s a topic we can discuss over the next beer.

For more information, email Jim Norman or Rick Hutchison at jim.norman@hklaw.com or rick.hutchison@hklaw.com, or call toll free, 1.888.688.8500.