India is a place of attraction for tourists around the globe. It offers one of the most breathtaking scenic beauties in the world. People visit India to experience the culture in varied forms. Usually, such tourists prefer to spend their vacations in luxurious hotels and the services provided thereof. However, one needs to understand how these services are provided to the customers. These hotels can broadly be of two types-
But the commonality among both of them is that such hotels are most often constructed as an investment by business groups or businessmen. Such owners of the hotels are not equipped with the skill set to operate them. It is where the need of a management team to ensure the daily operations of such hotels are carried out hassle-free. These management teams are equipped to handle such large luxury service providing establishments and ensure revenue/ profit to its owners and financers. This article explains the intricacies that one should keep in mind while drafting a contract to use the services provided by a management company. Such contracts are called management agreements.
The management agreement is a contract entered into between two parties, usually the owner and the operator, who agree to certain terms and conditions which result in successful carrying out of the business. The management agreement in the hotel industry is usually a deed amongst two people in which the owner of the hotel does not want to manage the hotel either due to lack of expertise in the hospitality industry or due to lack of time and other resources.
Hence, the hotel premises and their functions are asked to be handled by a management company, which provides services to ensure the Hotel turns out to be a profitable business and revenue-generating investment for the owner. Under a management agreement, the owner of a facility, asset, property, or business transfers the management of that asset, business, or relevant premises to a third party to manage in return for the payment of the management fee. The specific terms of such agreement may depend on the nature of the management, the premises, or the business to be managed. In general, a management agreement will set out the parties’ (wherein one party is the owner and the other party is the manager.) respective obligations. It may concentrate on the owner’s obligations in respect of the premises and the manager’s obligations in running the business or premises.
A management agreement will set out agreed provisions, indemnity and liability terms, arrangements in relation to performance, exclusion or limitation of liability, fee, and basis of calculation, warranties, and indemnities together with the usual boilerplate provisions. While a management agreement relating to a revenue-generating property, whether a club, hotel, or other premises is similar but not identical to outsourcing agreements. It is different from a franchise agreement because the franchise builds its own business using the brand and process of the brand owner (and shares a royalty).
A non-disturbance agreement is a tripartite agreement between the owner, finance, and operator of a revenue-generating property, which in the present case is a hotel. This agreement is imperative to a hotel management agreement because it allows the parties to ensure that they are carrying out their respective duties independently without any unreasonable interference.
This clause should be drafted in a manner where the parties agree to their duties and responsibilities assigned. This clause sets the ground rules which ensure that the parties are not interfering in the work of others and hindering the operations of the hotel.
This clause ensures the duties of the parties are carried by them independently in the manner like: the financier of the property is getting financial status and account statements for auditing of the hotel accounts. It also indemnifies the financier if the owner defaults on any payment. This also gives the operator an opportunity to tender notices to the owner and financier about the functioning of the hotel at regular intervals of time.
The owner of a hotel has a certain brand image in his head that he wants to continue to flourish under the aegis of the operator. This upliftment of the brand image and standard of the hotel, in the long run, will ensure that the management agreement of the operator is renewed on a timely basis. Moreover, a rise in the reputation of the revenue-generating property will give greater profits to the owner and the financier too.
However, if the operator is not able to comply with this clause/ breaches the contract of holding the brand standard, reputation, and customer satisfaction then he will have to pay an amount specified in the contract.
The manager agrees and undertakes with the owner as follows:
A termination clause is one in which the owner has an option of exiting the contract due to the default of the operator. In a management agreement for a hotel, an owner usually has very little option to exit the contract. This is because the operator can pay for the losses suffered by the owner.
However, care must be taken while drafting this clause and mentioning the parameters according to which the operator is supposed to perform and will be judged by the owner. A continuous underperformance by the operator during his tenure in managing the hotel shall give the owner an exit opportunity from the contract.
While drafting this clause, one must also take care that the clause is drafted in such a manner that if the owner wishes to exit the contract upon the default of the operator, he is able to do so without any liability.
It may reserve the right to terminate without cause but should expect the operator to require payment of a termination fee equivalent to its anticipated return over the unexpired duration of the contract.
This deed shall automatically terminate upon any of the following events:
The owner and operator might get into a legal tussle which requires a solution. This solution can either be through the mainstream i.e. litigation or the parties can even go through alternative dispute resolution available in India like arbitration, negotiation, mediation, conciliation, and Lok Adalats.
However, care must be taken while drafting this clause in the sense that the negotiating powers between the disputing parties are balanced out. There should not be an imbalance while deciding on the issue at hand.
The prime motive of the owner while handing over the hotel to the management company is to handle its day-to-day operations and generate profits from them. The task might seem easy on the outside but it really is a tedious and demanding job.
But once this job is not fulfilled up to the standards agreed to by both parties, it is called a breach of contract. although, it is not just limited to meeting profits but also about maintaining the standard of the hotel, providing customer satisfaction, building a brand, and the reputation of the hotel.
However, if any of the tasks and milestones are not achieved by the management company, then there should be an appropriate mechanism to deal with such an issue. Usually, such breaches are met through payment of a specific amount by the breaching party either in a lump sum or in installments.
The owner of the hotel may not be involved in the day-to-day operations of the hotel due to a lack of expertise and time as a resource with him. But he retains his status as owner of that hotel.
This does not give the rights to the operator to execute a sale of the hotel. But if this happens, then appropriate measures should be taken by the owner against the operator in terms of the losses faced by him and breach of contract. If the owner wants, then he can even criminally prosecute the operator.
This clause also ensures the right of the owner or the landlord of the lease agreement (hereafter, the landlord of the present premise on which the business of the owner is addressed. These rights include permissibility to the owner or the landlord to enter the premises of the business, to inspect the premises in order to identify any damage, to ask for documents or records relevant to the business, etc.
There are sometimes where the hotel is built upon land that is on lease by the owner. Hence, care must be given while drafting this clause in the contract ensuring:
The owner might create the operator status of the business if the management agreement is drafted incorrectly. This is because the tenancy requires only the feature of having access to the premises of the revenue-generating property for a defined period of time.
It explicitly specifies that the rights which are transferred to the manager by the owner related to the business are to the extent of its operation and management. The right to determine the selling of the business to another person is reserved with the owner himself.
This clause of the agreement should be carefully drafted, after completely negotiating with the manager the amount of profit to which the operator will be entitled to except the income earned through the business investment, which in the present case is the hotel.
The owner agrees at all times during the term to pay to the manager in respect of the rights granted under this deed a percent of the profit, which is calculated in accordance with the provisions of the schedule to this deed.
The operator of a hotel is the one who handles the day-to-day tasks and responsibilities of the hotel to ensure it lives up to the market standards and continues being in the top rank. The rewards of this business in monetary terms are called the rate of investment for the owner. The services rendered by the operator should be paid by the owner through a percentage based on the income generated by the hotel business and a base payment too.
This base income/ fees to be paid by the owner to the operator can be decided upon by a simple formula:
This clause ensures that the management agreement is renewed between the owner and the operator. While this clause is completely different for both parties in the sense that the owner might want a shorter duration for renewal time, while the operator might need a longer duration of managing the operations of a hotel.
This is because the owner would want to renew the agreement only if the hotel is a success i.e. the rate of investment is reaching the threshold. However, the operator might need a longer duration to ensure that they are able to render their services for a longer duration and ensure continuity in that.
This clause should be carefully drafted especially in those markets where tourism is not that overwhelming. Longer duration of operations for both the owner of the hotel and operator in disappointing market conditions, will not give either of them the opportunity to exit the contract.
This deed shall commence on 23 May 2021 (the “Commencement Date”) and shall continue in full force and effect until terminated in accordance with those terms of this agreement.
The hotel owners are usually not equipped with the requisite skills to manage a hotel’s day-to-day operations. This is where the need of a management company/operator comes into being where the duties and responsibilities are given to them.
This clause needs to be carefully drafted which distinguishes the departments in which the Operator will be functioning and the areas where the owner will be functioning. There should not arise any disparity between the owner and the operator when it comes to the fulfillment of their duties effectively and efficiently.
Moreover, there should be a negotiation between them as to who can perform the tasks at hand more efficiently so that the profits of this business are not compromised. Another reason to draft such a clause with precision is to ensure that the future rise in disputes is minimised among them. The primary cause of such future issues could be an assumption of performance of duties by either of them if those duties are not mentioned in the agreement clearly.
The operations of a hotel are not those tasks that can be single-handedly performed by just the operator. It is a complex task that requires a lot of trained personnel. This clause should mention the employment of such personnel and also mention who would employ them, whether it’s the operator’s duty or the owner’s responsibility. However, if the owner of the hotel decides to employ this personnel then the liability to such employees should be reduced to avoid any future conflict with them.
A non-compete clause is a standard clause in all commercial and even employment contracts which usually are drafted in favour of the employer to reduce the competition in the same line of business. However, if this clause is inserted in a management contract, then the operator should ensure that the implementation of this clause is towards a limited/defined area and not an unreasonable area like that of a country or continent.
The operator should be given the responsibility of reporting the financial status and accounts of the hotel within regular intervals of time to the owner and even the financier. There should be transparency among the three of them when it comes to monetary issues to ensure the smooth functioning of the hotel. The operator should be given a budget of expenditure to ensure that the brand name and the reputation of the hotel are maintained. On the other hand, the operator should maintain accounts of the hotel in acceptable accounting standards and even send these accounting books for auditing from time to time. There should be a clear demarcation of what expenses are to be borne by the owner and the operator.
Working capital is the amount of capital/fund available that determines the short financial position of a business. This fund is set up to smoothly carry out day to day operations of a business. In the present case, the operator of a hotel should be allowed to set up some funds for the purchase and maintenance of the furniture, floor, and other equipment in the hotel. This fund is usually set up from a percentage of the gross revenue.
Moreover, this working capital is imperative for maintaining the brand image of the hotel as its furniture, floor and other daily use equipment are prone to excessive wear and tear over time. Low working capital will just not be sufficient to take care of such expenses and just delay the payments which in turn one day will accumulate and be difficult to be paid off. This ultimately will ruin the image of the hotel by lowering customer satisfaction.
2. The owner agrees in addition to the grant of the right to use the name and to make available to the manager the use of all fixtures and fittings, equipment, and furnishings presently in and on the premises;
3. The manager agrees and undertakes with the owner as follows:
The drafting of this clause in a management contract should specify the relationship between the owner and the operator where the operator acts as the agent of the owner. This limits the liability and even the decision-making authority of the operator. There should be a coping mechanism fully laid out to suggest some solutions if there is an unprecedented issue at hand. This plan will help to mitigate the dispute and also help in reducing the risk of failing the business miserably.
The manager shall indemnify and keep the owner fully and effectively indemnified against any liability arising out of or in connection with any employees’ employment after the commencement date, to the date of the termination of the deed.
This clause is equally important as the above-mentioned clauses. This clause should clearly specify who has the intellectual property rights over the Hotel’s intel or such prized possession or data.
However, if the operator has such rights then there should be an explicit understanding between the parties to ensure smooth functioning of the hotel after the tenure of the current operator comes to an end.
A management agreement is of utmost importance as it ensures that the rights and liabilities of the owner and the management company are clearly demarcated. However, the above-mentioned clauses, their explanations, and the sample clauses are just for one’s clear understanding. But while drafting them, one must make sure that the clauses are air-tight, crisp, clear, and drafted in a manner keeping in mind the parity in the powers of both parties. One must also make sure that he/ she has ready alternatives of an agreement so that it saves time during negotiation over different clauses.
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