General commercial and governance practices would require Service Level Agreements and consequences on the service provider. While Hotel Management Agreements may have some provisions as well, the combination of provisions renders the ‘balance’ ineffective, substantively nonexistent. The first read of a management contract leaves you in doubt as to whose benefit the hotel is being built or used for, with the operator and brand seeming to be the forerunners. They have full control and authority but limited acknowledged responsibility, and longevity of contract and rights. The owner carries the primary burden of risk with residuary status by way of earnings over which owner has limited effective control and the inability to sack an under-performing service provider—dentures and not real teeth, but lots of obligations. And a repeated reminder of his obligations, liabilities and potential claims; of course, the operator's obligations are stated in tightly worded legalese—with a sharp reluctance for restatement or repetition.
The management companies will of course strongly disagree—explaining that there is a lack of understanding or appreciation of their role, with repeated fallback on the arguments that the brand is sacrosanct (no dispute there) and that the owners' share of earnings is materially larger than the earnings of the management company. Of course, the achievement of these larger earnings is entirely in the operator's control and is subject to the owner approving Opex and Capex for brand standards—on demand—and providing additional funds, also on demand.
None of this is new and has been adsorbed, digested, modified (where possible) and adopted. Contracts in certain jurisdictions are more evolved than in other newer growth territories (where I come from and which tempers my comments). Yet some newer aspects need examination.
Firstly, the requirements around data security and data privacy and the increasing legal liabilities arising from breach. The operator has complete control over the data, its processing and use; reservations flow through global systems that are entirely under operator's control—both aspects are fully accepted as being necessary. The owner has no visibility of the depth and quality of operator systems and effective controls, particularly in the face of rapidly changing threats and response needs. It then seems incongruous that the owner must carry the penal liability burden because the operator liability, under normal HMA, arises only under conditions of gross negligence or willful misconduct—both of which are difficult to prove and will, of course, be heavily contested. If you seek complete control in operations, and reliance on your global systems and unit level implementations, then you must remain liable for the consequences of breaches and failures. The owner must provide funding sought for requisite systems but then has a right to be indemnified for the liabilities—he should not be required to carry the burden of claims arising from a subject on which he lacks a modicum of control or even review.
Older agreements, made before several new legislations, have no consideration of this matter, and must be re-opened at the earliest opportunity. New agreements must address this aspect. Sure, there is insurance and that can be the first port of call for liabilities; but any balance liabilities must rest with the operator. And mark the risk from the argument that the operator sets policies and provides guidance, training even, to employees whose action could lead to a breach—but the employees are of the owner. What about the rigor of supervision and effective controls? The fact of employees being of the owner does not dilute the operator's obligations except where the employee acted with rogue intent and well-set systems were unable to prevent the action.
Second is the rigidity of approach toward performance tests. Who likes them? No one does. But then these are essential to at least provide a modicum of control to the owner, particularly in the face of long duration contracts. But one faces the insistence of competitive RevPAR based tests in markets where the creation of a competitive set is highly unlikely, and almost certain not to occur through several years of the contract. This constraint is further compounded by the eligibility conditions attached to the selection of compset hotels. Consequently, it is apparent that there will be no compset for years to come and hence the test is rendered non est. But lo, we cannot have any alternative criteria—management company policy. And no, we cannot have shorter contract durations as well. In substance, the operator is practically without a check. That much for governance!
An interesting third issue one sees is the ability of the operator to walk out of a contract if target completion dates are not met—and this is fair. But if the owner has not been able to implement the project for several years, due to external factors, and market circumstances have changed thereby warranting a different product or arrangement—no no, the contract is enforced and the owner must build the original product (irrespective of circumstances) to satisfy the commitment to the operator. Operators almost have a long-term lien on the asset, irrespective of the owner's commercial and financial interest. Owners must have a sunset clause in the contract as well, even if under guarded conditions.
Lastly, the proliferation of brands by several hotel companies has its advantages—for the operator, for the market and several prospective owners. Existing owners in the meantime, see a vast increase in comparable supply—under the same sales system and loyalty program—thereby potentially diluting business flow for the hotel. Undoubtedly, there can be no restraint on operator growth, but there is a sense of balance that is lost when the new brand proliferation is extensive. This is something to ponder over as new contracts are negotiated and owners need termination options for cause and, in specific circumstances, even without direct cause.
About the Author
Vijay Thacker, FCA, is the managing director of Horwath HTL India and partner and CEO of Crowe Advisory India. With an illustrious career spanning nearly four decades, he has been a pivotal figure in the evolution of the Indian hospitality industry since 1986.
This article was originally published in the June/July edition of Hotel Management magazine. Subscribe here.