Hotel Management Agreements

In 1991, a California court, applying California law, in the Woolley versus Embassy Suites case sent a startling message to hotel management companies. At the time, those of us who follow these kinds of cases thought the holding was a one-off, quirky decision that is not likely to be followed and may be overturned in subsequent decisions.

It held that a hotel management agreement is not only a commercial contract that sets out the rights and obligations of the parties, but it also gives rise to an agency relationship. In that relationship, the management company is the agent and the hotel owning company is the principal. As such, under common law agency principles, the court held:

a) The owner has the power but maybe not the contractual right to terminate the agency relationship at any time, although it may face a contractual monetary damage claim if the management agreement was wrongfully terminated;

b) Once terminated, a court lacks authority to re-instate via equitable relief; e.g., an injunction ordering the owner to reinstate the management company the hotel management agreement because of its characteristics as a personal services contract;

c) The agency would not be terminable if it is “coupled with an interest”; e.g., the management company did not have a “present property interest” in the Embassy Suites hotel, but was just providing a service for a fee.

Then came another California case in 1993 with a similar holding: Pacific Landmark Hotel, Ltd. versus Marriott Hotels, Inc. that also extended to hotel management agreements the common law agency principle that the agent; i.e., the management company, owes to the principle; i.e., the owning company, a fiduciary duty that at law is likely to be a much higher standard of care, akin to what a guardian owes a child. This standard of care is not what one would find or even expect to find among the terms of a commercial contract such as a hotel management agreement.

At this point, these holdings seemed idiosyncratic to California law where “cutting edge” legal concepts are spawned, but many do not survive or spread. But this was not the fate of the agency analysis of hotel management agreements. Instead the concept expanded to other states whose laws govern hotel manager/owner contracts.

The cases are too many and too nuanced for analysis in this article. But notably, New York law, that governs many hotel management agreements and other commercial contracts, also came to include the principle that hotel management agreements are revocable agency appointments. E.g., the Federal District Court holding in the “Turnberry Case” – FRR TB, LLC versus TB Isle Resort, LP – where New York law governed the hotel management agreement, although the Fairmont resort was in Florida.

So, without detailing all the intervening cases, about which much has been written, the legal “agency” principle now seemed entrenched. Like it or not, although a hotel management agreement these days is the result of a long and tough negotiation between two very sophisticated parties, perhaps Marriott or Hilton on the one hand as “manager” and a huge publicly traded REIT or insurance company on the other hand as “owner”, the owner enjoys the added common law benefits arising from the “agency” analysis.

The owner may still invoke agency principles as overlaying and superseding the provisions of the agreement and (i) exercise the power of termination, (ii) allege violations of the fiduciary duty, typically for self-dealing not in the best interest of owner, and (iii) resist any attempt by the terminated management company to seek judicial reinstatement of the agreement. If as a matter of contract law the exercise by the owner of its power to terminate the management agreement was wrongful, that owner may face a contract damage claim; i.e., a claim for a monetary judgment for wrongful termination.

But to a judgment-proof owner, this threat may be meaningless and to the management company, a lawsuit for monetary damages is time-consuming and costly with an uncertain outcome.

In 2005, Marriott responded to all this “mayhem” by petitioning successfully the Maryland Legislature to pass a law that became Section 23-102(a) of the Commercial Law of the Code of Maryland.

That statute provides that “[i]f a conflict exists between the express terms and conditions of an operating agreement and the terms and conditions implied by the law governing the relationship between a principal and agent, the express terms and conditions of the operating agreement shall govern”. The statute also provides that a court may grant “specific performance”; i.e., an injunction – for an anticipatory or actual breach or attempted or actual termination of a hotel management agreement even if an agency relationship exists between the parties. Id. § 23-102(b).

The statute clearly is aimed at negating the common law overlay that gives owners the power to terminate a management agreement and that denies to the manager the remedy of court-ordered reinstatement. Instead, the law provides that the terms of the negotiated agreement between the parties governs their respective rights, without added help to the owner from a common law overlay. This really seems to be what many of us might expect. Hence Marriott and other hotel companies now seek to have their management agreements governed by the law of the State of Maryland, no matter where the hotel is situated.

But then the New York courts added an odd twist. In Marriott International versus Eden Roc, an appellate court in New York, reversing the lower court, decided that the hotel management agreement in question “is a classic example of a personal services contract that may not be enforced by injunction”.

Further, the court held that the agreement “is not and agency agreement”. Now that is confusing. So at this juncture, in New York, the law was that hotel management agreements may not constitute an agency appointment or give rise to an agency relationship, but even so, they are terminable by the hotel owner.

IN addition, these agreements may not be enforced by injunction because they are personal services contracts. So much for the prior analytical clarity, wrong though it may have seemed to many of us who follow these cases.

But it does not end there. In a recent 2017 case, Chelsea Grand, LLC versus Interstate Hotels & Resorts, Inc., a Federal District Court in New York, applying New York law, held that Interstate Hotels, as the hotel manager (“operator”), does NOT owe a fiduciary duty to the hotel owner. The result seems right to some of us, but the analysis is very strained.

The court concluded that because the management agreement between Interstate Hotels and Chelsea Grand Hotel did not create an agency, even though the management agreement expressly states that the manager – “operator” – is owner’s agent, there is no fiduciary duty. But the management agreement in question contains the following language.

3.2 The operator (Interstate) as agent for the owner to perform enumerated tasks;

5.1 “…the operator shall act solely as agent of owner”, but will not be construed as a “partnership or joint venture between owner and operator”;

6.1 Operator shall act solely as agent for the account of the owner, but will not be in default if there is a lack of funds from the operator of hotel or as otherwise provided by owner.

So, where does all this leave us? Owners and management companies alike are left in a very murky legal environment where hotel management agreements are accompanies by an overlay of contradictory and uncertain principles of common law. Somewhere out there may be a case that will clarify all this. It likely involves a dispute between an owner and a management company where the owner purports to terminate the agreement, perhaps without even giving notice or complying with other contractually mandated requirements, such as allowing the management company its contractual right to cure the alleged default.

And there is a judge out there who will hold that the hotel management agreement was carefully drafted by capable lawyers and negotiated zealously by both parties. Then maybe the court will leave the parties to the bargain they freely negotiated that is embodied in their commercial contract, without resort to common law agency or personal services principles. In my view, that will add certainty and clarity and leave the parties to the deal they cut, with no added help from the common law to one or the other.