June 16, 2009
By John Walsh
 

As if there aren’t enough problems and concerns in the industry, add this one to the list: an increase of the number of management disputes, which stems from owners who have a shortage of funds caused by the economic recession.

A case in point: the Four Seasons Aviara in Carlsbad, California. Four Seasons Hotels and Resorts refutes statements by lawyers for Broachreach Capital Partners/Maritz, Wolff & Co., the owners of the property. The statements are related to the owners’ attempt to take control of the resort from Four Seasons, the contractual managers. Four Seasons claims legal rights to manage the property until 2087, and claims the contract states any dispute that arises be handled by arbitration.

Peter Connolly, principal of Parthian Partners and former general counsel for Hyatt Hotels Corporation, said the origin of almost all management disputes is the same–the hotel isn’t performing.

“Seventy percent of the time it’s because of the economy,” he said. “When there’s a lack of performance, the question is who’s fault is it and who shoulders the blame? If it’s nobody’s fault, then what do you do with the management company?”

Catherine DeBono Holmes, a partner with Jeffers, Mangels, Butler & Marmaro LLP, which has represented owners in disputes for 20 years, said the firm is seeing more disputes because of the economy.

“Owners generally are happy with the management company when times are good,” she said. “But sometimes management companies take money off the table owners could be using to pay debt.”

Mike Marshall, president and CEO of Marshall Hotels and Resorts, a management company based in Salisbury, Maryland, also said management disagreements lately are more common lately because of properties lacking revenue.

“When some hotels opened this year, they expected to come out of the box cruising and hit their feasibility projections, but they never had enough cash reserves to get through the winter,” Marshall said, adding that many times owners wait too long to hire a management company to help turn things around. “We’re constantly making cash calls to meet payroll and keep the lights on.”

Marshall, who specializes in turning around distressed properties and opening new ones, said other management companies, as well as banks, are experiencing a lot of the same thing.

“With some disputes, we give owners our walking papers, and we no longer manage those properties,” he said. “If the owners want us to compromise the franchise, we say, ‘Absolutely not. We can’t.’

“We walk away if it’s so unbearable for the accounting staff to take numerous phone calls a day,” he added. “If we’re spending so much time keeping them going, it doesn’t make sense for us. We don’t get paid. We’ve been generous with owners by not paying ourselves only if there’s a light at the end of the tunnel. If there’s no light, we move on.”

If that’s the case, Marshall wants a clean break. If it’s messy, it’s because the owner owes the company money, he said.

In some cases, owners try to downgrade the hotel and change flags. Marshall cited two cases in which the franchise was lost altogether.

Companies will try to relax brand standards due to the economy without prostituting the brand, Connolly said. With some brands, such as Four Seasons, it’s more difficult to do than others because there’s less wiggle room in the luxury chain scale.

Fees and payments

Holmes said management companies can charge central service, loyalty program and marketing fees that don’t help the owners, just the management companies.

There’s been a large number of hotels built the past decade because of easy money, Holmes said. Some of the current problems arose because new owners who didn’t understand the intricacies of hotel operations hired management companies who added hidden fees. In other cases, people who did understand the hotel industry realized that management agreements that were fair at the time the contract was signed no longer were fair.

Holmes said there are more problems with owners that aren’t as knowledgeable about the hotel industry. They go to consultants and tell them about the fees management companies are charging.

“It’s not fair,” she said. “Even though management companies are disclosing the fees, people don’t focus on them when they’re opening a four- or five-star property.”

Holmes said a fee might start out as one amount when the contract is signed but increase over time without the consent of the owner. Some contracts state management companies can add on to services they charge, she said.

Connolly said management companies taking advantage of owners with hidden fees is “an overblown bunch of hooey,” citing the seminal Woolley case that applied agency law to the hotel-manager relationship.

“There’s no question, a prudent management company discloses all those fees,” he says.

If a property isn’t performing well, a management company might be willing to postpone its payment in the most extreme circumstances. What will happen most frequently is that the owner will agree to delay capital upgrades in the hotel. Management companies will defer some fees but not many, Connolly said.

Marshall said his company is getting more calls to manage distressed properties.

“Some owners call us and want us to work for free for the first year and defer our payments, but we said no,” he said.

Skin in the game

Holmes said owners and lenders are taking a bigger risk as long as a hotel is open and that management companies receive fees off the top.

“Many management companies have been stacking contracts on their side for the past 10 years,” she said. “You can’t kill the goose (owner) that lays the golden egg (hotel). Give lenders and investors enough money for them to hold those properties. We want to see more management companies understand the overall economic impact of ownership and to adhere to economic benefits of the owners.”

Owners need equity, and if they don’t want to invest any more money in a property, they need to find someone else, Connolly said. Banks most likely will say no so the owner might get rid of the existing management company if it doesn’t want sliver equity and find another company who does. Sliver equity with a management company is a common tool, but it’s not happening a lot yet, he added.

“It will only be in last quarter of this year that ongoing working capital will become more of an issue,” Connolly said.

And for many owners, it’s not financially prudent to change management companies because it costs US$8,000 to US$12,000 to change the property’s flag and it takes time for a new manager to get up to speed to perform as well as the previous management company.

“A lot of people overlook the best option, which is to sit down and go over the weekly numbers,” Connolly said. “Ask for concessions on brand standards and capital. If a manager says, ‘No, I don’t care,’ then look to change managers. But most managers are sympathetic and look to help the owner.”

Prevention and recognition

To prevent more disputes, Marshall has been much more diligent in prescreening the properties the company is looking to manage. He’s looking at the physical product and accounts payable.

“We require a minimal capital balance, which is enough money to pay for a month’s utilities and payroll,” he said. “That number is determined through a pro forma.”

Marshall said a lot of underperforming properties are in a bad location, and in most cases, the owners paid too much for the property or had other real-estate projects that sucked capital out of the hotel.

“It all comes down to money,” he said. “Rarely will we get into disagreements about sales and marketing or the daily operation of a hotel. We’re good at what we do.”

There will always be management disputes because of the intentions of both sides, so both sides have to recognize the economic benefit of each, Holmes said.