Colorado Real Estate Journal -
The balance between hotel owners and operators has dramatically shifted with the recent decision of the New York Appellate Division in Marriott Int’l Inc. v. Eden Roc. Since many hotel management agreements are governed by New York law, the decision’s impact will be felt beyond Manhattan. Indeed, the dispute involves the storied art deco Eden Roc Renaissance Hotel of Miami Beach, Fla. In 2012, the owners sued Marriott, alleging the operator mismanaged the property after they invested more than $300 million in the hotel, including a $240 million renovation. When the hotel owner tried to evict Marriott upon purported termination of the hotel management agreement, Marriott countersued and secured an injunction against the hotel owner on a bond of $400,000. In support, Marriott argued that reputational harm and harm to the good will of its brand constituted the necessary element of “irreparable harm” that justified an injunction rather than damages as an adequate remedy. Marriott accused the owners of attempting a hostile takeover and repudiated the attempt to terminate Marriott’s 30-year HMA. The New York trial court agreed and, ignoring various cases holding otherwise, further found that the HMA was not a “personal services contract” and that agency law principles would not be applied. So Marriott retained long-term possession and management of the property. In overturning and vacating the injunction in late March of this year, the New York Appellate Division found the HMA to be a personal service contract since the HMA placed full discretion with Marriott to manage virtually every aspect of the hotel. “Such an agreement in which a party has discretion to execute tasks that cannot be objectively measured is a classic example of a personal services contract that may not be enforced by injunction,” held the appellate court. As a result, the hotel owner was able to terminate the HMA, without proving cause under the specific terms of the HMA, and regained possession of the hotel. Following Eden Roc, by no means is a hotel owner granted a free termination, however. In the instance of a termination without cause, the owner may be liable for damages arising from the breach of contract – which could be considerable for breach of a 30-year HMA. The owner, in turn, will likely argue for offsets or lesser damages due to the economic consequence of an operator’s alleged mismanagement. The major consequence of Eden Roc, nonetheless, is the incentive for both parties to move to the bargaining table to negotiate a mutually acceptable termination payment and orderly transition of management when the relationship between owner and operator has soured. The Eden Roc decision, and similar decisions in Florida and California, hopefully will reduce some of the extreme behavior taken by owners and operators. Some operators with possession feel no reason to entertain or negotiate termination. Faced with the perpetual drain on capital, some owners feel compelled to plan a predawn hostile takeover of the property, which endangers employees and guests. Instead, given the reputational concerns of both owners and operators, termination negotiations are more likely to occur in private with the assistance of experts rather than highly publicized court proceedings. As a corollary, many owners and operators are now probably examining the termination chapters of their HMAs. Recently negotiated HMAs may not have included provisions for liquidated damages for a termination at will for fear that such provisions might actually be used. As the balance continues to shift back and forth, we expect operators will seek to incorporate sophisticated methodologies for determining liquidated damages in the next round of HMAs, perhaps following the existing tradition found in most hotel franchise agreements. Another corollary impacts hotel lenders. To finance a signature hotel during the last economic boom, the major brand management company commonly obtained a subordination and nondisturbance agreement from the lending group and, in some cases, recorded the SNDA or memorandum of agreement to ensure continued enforceability of the HMA after foreclosure. During the bust, however, an HMA once seen as a critical enhancement to the hotel loan was later feared to be an operating cash flow burden. In another extreme move, some lenders felt compelled to endure a friendly bankruptcy to ensure termination of an HMA. While Eden Roc does not directly examine the effect of SNDAs on long-term management agreements, it can be assumed that the foreclosing lender will have at least the same rights as an owner to terminate at will and bear some reasonable consequence. Dramatically, Eden Roc means virtually every hotel management agreement is now terminable at will, but more modestly we do not believe owners will rush to this decision. Most hotel classes have rebounded and new hotel development has begun, such as the signature hotel redevelopments in the Denver Union Station and the former Colorado National Bank Building. Most owneroperator relationships are mutually beneficial and amicable. But when relations break down, the negotiating table is more likely than the courtroom to produce a mutually workable result.