In addition to traditional key money, or those offered in “reverse” management contracts, guarantees are becoming increasingly common in hotel management agreements (HMAs). But are they all beneficial? And if so, how should they be negotiated?
1. The common practice of guaranteeing remuneration
Hotel owners are increasingly demanding that operators invest financially to demonstrate their commitment to the hotel management agreement1. Operators who choose to accept generally find it in their interest to do so – they stand out from the competition, may gain negotiating power on strategic clauses, and reduce the risk of the owner terminating the agreement.
Hotel operators offer several main guarantees based on operating performance to secure hotel management agreements. These generally include:
Performance testing: these performance clauses can lead to early termination of the HMA or payment of compensation to the owner if the operator fails to meet its performance expectations. The operator may also provide a guarantee relating to Adjusted Gross Operating Profit (AGOP)2.
Minimum Guarantee: here, the operator has to pay compensation to the owner if it fails to meet the minimum guarantee (i.e. a certain GOP amount, often capped, set in the management agreement). On this occasion, the operator may also provide a warranty that covers the minimum guarantee and, in return, claim the right to reclaim any repayment if the hotel’s operating results allow (i.e. if performance exceeds pre-defined minimum thresholds).
Owner’s Priority: the operator will only receive incentive fees if the hotel achieves a certain performance threshold.
2. Key money: a financial commitment from the operator
Key money is a sum paid by the operator to the owner when the hotel opens. Often calculated as a percentage of the operator’s capital or fees, key money may be guaranteed by the operator, and is used to help develop the hotel or cover renovation costs. However, negotiating key money may involve certain compromises, such as higher fees or a longer contract term.
Key money is generally amortised by the owner on a straight-line pro rata basis over the life of the agreement. In the event of early termination, the owner undertakes to repay the unamortised portion. Indeed, the operator will often impose a clause guaranteeing repayment by the owner in the event of early termination of the agreement3.
3. The specific case of “reverse” hotel management agreements
In a “reverse” hotel management agreement, the operator is the sole employer of staff, and passes on salary costs to the owner. This model is less common, but can be negotiated when the hotel is a strategic asset for the operator.
We believe that it is justified and indeed common for the operator to request, in return, a specific guarantee covering the owner’s reimbursement of social security expenses and other costs that it (the operator) advances. However, this guarantee must be both quantifiable and capped, in order to ensure its validity – the subject is not always treated with the rigour it deserves4.
4. Common guarantee practices in hotel management agreements
Independent bank guarantees are often preferred, but guarantees from parent or affiliated companies are also common (as they are less costly). The parties must ensure that these guarantees are legally valid and effective, particularly when foreign companies are involved. As the guarantees and the management agreement form a contractual whole which is in principle inseparable and indivisible, care must be taken as to the applicable law, language and jurisdiction.
Some management agreements even go as far as to include reciprocal guarantees of joint and several liability of parent or affiliated companies on both the owner and operator sides, to ensure that the parties’ contractual obligations are met. While these increase confidence between the parties, each party must ensure that there is a clear cap on its guaranteed commitments.
Consideration should also be given to the increasing prevalence of guarantee insurance taken out by the owner or operator – where the indemnity mechanism is transferred to the insurer rather than the parties. Before underwriting, the insurer will review both the management agreement and the representations and warranties made by the parties.
Benefits to the owner and operator: each party can sign the HMA without financial exposure for the duration of the contract and can improve liquidity while benefiting from the necessary financial security.
5. The relative usefulness of certain guarantees negotiated in management agreements
We could also mull over the many layers and practicality of certain guarantees that do not appear entirely rational when the owner or operator has the necessary financial capacity to enter into a contractual commitment (although it is still necessary for each party to prove this effectively and diligently with the help of advisers and auditors).
Finally, the inflation of guarantees can affect the assignability or transferability of hotel management agreements which can run for up to 20 or even 30 years. We must also take into account the guarantees already given by the owner in connection with the financing of the hotel, as well as the compatibility with financial arrangements such as property finance leasing or overseas tax relief (e.g. in the French West Indies).
6. Practical advice on negotiating guarantees in hotel management contracts, especially for first-time owners5:
- Prioritise guarantees: focus on the necessary ones first and then enforce them.
- Clarify guarantee expectations and caps: make sure all parties understand the implications of each guarantee.
- Maintain open communication: transparency helps resolve disagreements more quickly.
- Manage the pace: follow a structured timetable for dealing with guarantees and avoid slippage.
Following these steps can help make the negotiation process smoother and more efficient.
1 See our article on hotel management agreements on Hospitality Net : Hotel management agreements offer flexibility for hotel investment in France
2 See our article on hotel performance tests on Hospitality Net: Hotel performance test clauses in France – simple wording for maximum success
3 See our article on the subject on Hospitality Net : The practice of key money in hotel management agreements in France
4 See our article on the subject on Hospitality Net : Successfully negotiating a “reverse” hotel management agreement in France
5 See our article on the subject on Hospitality Net : Recommended governing law and jurisdiction clauses in French hotel management agreements
Christopher Boinet
FR – IE Paris – Avocats
In Extenso Avocats
