Magazine article Real Estate Issues

HOTEL OPERATORS OPEN PANDORA'S Box: FROM "AGENT" TO "FIDUCIARY" & BEYOND

Magazine article Real Estate Issues

HOTEL OPERATORS OPEN PANDORA'S Box: FROM "AGENT" TO "FIDUCIARY" & BEYOND

Article excerpt

ONCE UPON A TIME ... MANAGEMENT AGREEMENTS WERE INVENTED

Once upon a time hotel operators owned the hotels they operated. Then, needing to lessen the intense capital requirements of ownership, hotel companies began to experiment with franchising and sale-leasebacks. But "paradise" was not reached until hotel management agreements were invented in the 1970s and 1980s. With this device hotel operators had almost all the benefits of ownership and almost none of the risks and capital costs.

What could be better? Operators could build national and international chains of hotels bearing their brand names. Operators no longer needed capital to buy, operate and maintain the hotels. These burdens of ownership were transferred to owners under the management agreements. But operators could earn fees for managing the hotels and exercise almost complete control over the hotel. Owners assumed most (if not all) obligations to provide working capital, make up operating deficits, and supply cash to maintain the standards established or aspired to by operators.

To effectuate the ideal relationship, operators drafted the management contracts with owners granting powerful agency authority to the operators to maximize the operator's ability to control the hotel asset and to minimize the need to go to the owner for approvals or action of any kind. While these long-term, "no cut" contracts were largely successful in banishing many owners from any active involvement with the hotel, they created another problem that most operators never fully appreciated until recently.

TROUBLE IN PARADISE: AGENCY PRINCIPLES RULE HOTEL OPERATORS

Just when things were going so nicely, Robert E. Woolley became involved in a lawsuit with Embassy Suites over termination of Embassy's long-term management agreement on nine of the 17 hotel properties his partnerships owned. Woolley claimed that the management agreement created an "agency relationship" and that certain common law rules therefore applied to the owner-operator relationship. He claimed that these rules trumped the express language of the contract and enabled Woolley to terminate the management agreement. The Court of Appeals agreed with Woolley! It held that the hotel operator is an agent and governed by agency principles that overruled any provisions of the management agreement itself to empower Woolley to terminate the management agreements. [1]

Woolley was the first in a steady line of relatively new cases to apply centuries-old principles of English agency common law to hotel management agreements. [2] Nothing was novel about the agency principles applied. Hotel owners and operators were just not used to thinking about the full implications of an operator being an agent. Under the legal tests, virtually every operator will be an agent of the owner for the hotel managed. And almost every agency (including the management contract) can be terminated by the principal (owner) at any time, however, the owner will be liable for damages to the operator if the termination is not justified.

Suddenly, operators began to worry about the agency implications of the long-term management agreements that had proliferated in the industry since the 1970s and 1980s. And when a $51.8 million jury verdict against ITT Sheraton was rendered in 2660 Woodley Road vs. ITT Sheraton in December 1999, operators awoke with a start to find that the fairy tale had become a nightmare.

It should not have been a surprise once Woolley announced that hotel operators are agents, but many operators failed to appreciate all the implications of that decision. In summary, Woolley and its offspring establish the following principles for hotel operators:

* Virtually all hotel operators are agents. [3]

* Agents can be terminated by their principals (or owners) except in rare cases. [4]

* Agents are fiduciaries. [5]

* Fiduciaries owe special duties to owners and are not free to deal with them at arms length. …

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