The cost of a broken hotel management contract

Although some people claim to have foreseen the onset of last decade’s world financial crisis, the truth is that almost no one anticipated the depth of the resulting recession. Even if a person had prior knowledge, that would not have changed the assumptions built into existing hotel management contracts—assumptions that became moot when the economy crashed and the travel business dried up. Despite hotel managers’ and owners’ best efforts, eventually a number of hotel operating agreements were terminated, and that termination often occurred without the managers’ prior knowledge or consent. More than once the termination occurred in conjunction with an owner’s bankruptcy proceeding.

But a contract has a value, even one that is broken due to remarkable extenuating circumstances. It turns out that a contract’s value can be quite large, as explained in a report from the Cornell Center for Hospitality Research (CHR). The report, “Valuing Hotel Management Agreements after an Involuntary Termination,” by Jan A. deRoos and Scott D. Berman, is available at no charge from the CHR and also from the Cornell Center for Real Estate and Finance. DeRoos is a professor at the Cornell School of Hotel Administration, and Berman is the industry leader for the hospitality and leisure sector for PwC.

The authors point out that most owners and management firms were able to settle their contract issues by negotiation—and this is the preferred approach. Inevitably, however, “some have resorted to litigating in court”—and the courts have determined that the broken contracts “may” have considerable value, in part because those contracts run for many years. The report notes that the courts calculate all the lost fees for what would have been the contract term, and that usually includes many years, if not decades. In their report, deRoos and Berman explain how to make a fairly solid calculation of the damages that would result from the involuntary termination of a hotel management agreement. They found, for instance, “that the courts prefer more than simple general averages and estimates, but the diligence of a more definite valuation analysis.” Again, they emphasize that it’s better to negotiate differences than to go to court.

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