May 10, 2012

Hotel Technical Services Agreements: Lessons Learned - The Hard Way

Holland & Knight Alert
Allison McCarthy

In any new-build hotel or resort project, the brand agrees to provide certain planning, equipping, design and opening services to the project owner or developer for a technical services fee. The most important goal of the technical services agreement (TSA) is to ensure that when completed, the hotel or resort will comply with the brand standards and be operationally efficient.

The management agreement and TSA are customarily negotiated and signed prior to breaking ground on the hotel project. Therefore, by necessity, some TSA provisions are broadly drafted in order to accommodate many unknown aspects which are associated with the project’s planning, design and construction. This inherent limitation on specifics can create future problems and disagreements to the detriment of the parties and the project.

Uncertainty Is Certain

No matter how carefully a hotel or resort project is planned, however, there is always some aspect of the project that does not go as planned. Remember the old saying about “the best laid plans of mice and men”? Given the certainty of this uncertainty, it is surprising how little attention is given to negotiation of the TSA compared to the highly negotiated terms of the management agreement for the same project.

A recent decision issued by the Supreme Court of the State of New York in a case regarding the design and construction of the St. Regis Hotel & Residences, in Fort Lauderdale, Fla. discusses in great detail the owner/operator disputes relating to the design, construction and opening of the project, and how the terms of the technical services agreement affected the project and the working relationship of the parties ? ultimately resulting in failure of the relationship of the parties, loss of the brand, construction and opening delays, and much higher construction and debt service costs. The lengthy decision shows what went wrong through an analysis of the actions of each party and then assesses the legal liability of each party that resulted from the TSA language and the conduct of the parties. Although this decision is fact and project-specific, the case illustrates the importance of the TSA and provides a virtual textbook on what to do and not to do by each side in the development of a hospitality project.

Design Professionals

Although the owner is responsible for engaging the design professionals, the brand will retain certain approval rights over the project architect, interior designer, engineer, contractor and other principal consultants. The parties may agree to include a list of acceptable or pre-approved design professionals in the technical services agreement or further define the scope of these approval rights by including a description of minimum criteria that the professionals must meet. In the Castillo Grand case, it was found that the TSA did not specifically define the scope of the brand’s discretion in approving the design professionals, effectively leaving it to Florida law to instead provide for the scope of such discretion. Since Florida law requires the parties to act in good faith, which limits a party’s ability to act arbitrarily or capriciously in exercising its discretion, the court had grounds to conclude that the brand had exceeded its contract rights by the way it became involved in the interior design professional selection process that went well beyond the initial approval of such professionals.

Design Standards

The owner has the obligation to manage the construction of the hotel project in accordance with specified brand design and construction standards. The parties may agree in the TSA to further define the scope and level of detail of these approval rights. These definitions should contain, at a minimum, certain objective design and construction standards that can, in the event of a disagreement, be evaluated by a third-party expert. Many brands have a design guide that may be referenced in the TSA in order to establish those items that define the essence of the brand. If there is not a design guide, the parties should take care in describing objective design and construction standards to protect each party’s expectations. In the Castillo Grand case, the TSA referenced a multi-volume design guide in describing the standards to be met, which the court determined never existed. The court concluded that it was not possible for the owner to construct a hotel in conformity with a design guide that did not exist. Without the existence of objective standards to use to measure the quality of the submissions by the owner, the court characterized the brand’s review of certain of the project components to be subjective and arbitrary, particularly where prior approvals were later reversed.

Timing and Form of Approvals

With no objective standards being in the TSA, the court found that getting brand approval required doing whatever was necessary to make the interior design of the project appeal to the personal taste of the decision-makers of the brand’s corporate executives. Complicating matters was that the executives and the design team changed completely during the course of the project. With the “meter running” on the construction loan, the owner began to rush the normal design and construction process to an extreme “fast track” called “caveman construction.” In this “process,” portions of the hotel were built by educating the subcontractors using sketches, notes and instructions from the interior designer, rather than formal construction drawings. Errors, problems and compromises resulted, along with escalating conflicts between the owner and the brand.

The court identified several shortcomings within the TSA in this area:

  • The timeframes for the brand’s review and feedback were not consistent with the construction schedule.
  • When objections were raised by the brand, it was not obligated to state the reasons for the objection or give potential solutions.
  • The resulting confusion and conflicts between the parties during this process escalated to a point where the brand undertook the design lead and forwarded to the project owner and the interior designer their design for consideration ? the reverse of the expected process. It may have made some sense in the context of the moment, but it also created a new liability for the brand that it never contemplated.

All sides to the hospitality industry, owners, brands and operators would do well to read all 80 pages of the Castillo Grand case. This article focuses on one aspect of the problems of one project. What’s important is not looking at who won and who lost, because the answer is that both sides lost. So did the project. Uncertainty is not a friend to the development of the project. When problems arise under the TSA, the relationship of the parties may be irreparably damaged, and other agreements, such as the management and license agreements, may never get the chance to provide the long-term benefits that were so heavily negotiated.

The TSA is not “just another agreement.” It requires coordination with other agreements, including architectural, engineering, interior design, specialty design, construction and loan documents. Those who treat the TSA process lightly do so at their own peril.

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