The owner’s exit strategy must be considered as soon as the operator is selected, and the Hotel Management Agreement (HMA) negotiated. Indeed, a well-structured exit strategy can help avoid a costly dispute and preserve an asset’s value and liquidity. The following key points, illustrated by real-life examples, should be considered.
1. Contract term: striking a balance
Hotel operators typically offer in France long-term agreements, ranging from ten to 20 years – sometimes up to 40 years for international chains. The challenge for owners, then, is to balance security and flexibility.
Example: one of our clients who owns a four-star hotel in Lyon negotiated a 12-year term (instead of the 15 years initially offered) to align with their bank’s financing plan. The agreement included a renewal clause, provided there were no breaches. This approach enabled the owner to adjust their strategy by negotiating a regular performance review of the operator (based on objective contractual criteria such as GOP, RevPAR or compliance with maintenance obligations). Our client was thus able to exit the contract after a short period of time.
Consider:
- A term in line with asset depreciation (building, FF&E).
- Possible asymmetry: i.e., a shorter term for the owner than for the operator, with an early termination clause at the owner’s convenience (see below).
2. Clauses to include before the HMA comes into effect:
If the agreement is signed before construction or renovation work on a hotel is completed, the following clauses must be included:
- Final delivery deadline: in the event of a delay that cannot be attributed to either party (e.g. permit or financing issues), the agreement may be terminated without compensation. Real-life example: a project in Bordeaux was cancelled at no cost after an 18-month delay to the works, on the strength of a well-drafted clause.
- Interdependence of contracts: linking the HMA to the operator’s Technical Services Agreement enables simultaneous termination in the event of an issue with either agreement (Article 1186 of the French Civil Code).
3. Negotiating the option to convert the HMA into a franchise agreement:
In some instances, a hotel management agreement may include a “flip to franchise” option after three to five years. Although this solution does incur costs, it gives the owner more autonomy, while maintaining brand recognition. However, in the event the hotel is sold, the operator will continue to benefit from the assignment clause (that governs the transfer of rights under a contract), which will limit the number of potential buyers.
Attention:
- Verify that a franchise agreement is actually beneficial (costs, obligations), and properly negotiate it.
- Negotiate this option (fees and transfer costs) at the time of signing as it is (very) rarely added later.
4. Integrate the impact of the legal framework governing mandates applicable to most hotel management agreements in France:
Hotel management agreements are usually mandates (Articles 1984 et seq. of the French Civil Code) and are typically entered into intuitu personae, based on trust between the owner (principal) and the operator (agent) .
The owner benefits from greater flexibility in terms of termination, which can be initiated at any time, although compensation is required unless the operator is at fault. However, trust may be broken if the operator commits a series of wrongful acts.
Recent French case law trends and developments:
Case law has ruled in favour of validating the termination of a mandate in the event of a loss of confidence in the mandate holder, subject to the provisions of Articles 1984 et seq. of the French Civil Code (which could be used for inspiration).
As outlined in Article 1993 of the French Civil Code, the operator is required to submit regular management reports. The decision of the Paris Court of Appeal on 9 November 2012 is worth recalling here, upheld as it was by the Court of Cassation on 4 November 2014. This case considered that, even if the operator has a certain degree of discretion in managing a hotel, they must report on their management to the owner-principal. Breach of this obligation justifies termination of the agreement for serious misconduct on the part of the operator.
Despite written reminders, the operator had failed to submit detailed monthly financial statements for 12 consecutive months.
- This obligation was expressly set out in Article 5.2 of the agreement, which incorporated the provisions of Article 1993 of the French Civil Code (the agent’s obligation to report on its management).
- Case law reference: the Paris Court of Appeal had already penalised such a breach in a ruling dated 9 November 2012 (RG 12/12982), a decision upheld by the Court of Cassation on 4 November 2014 (appeal no. 13-10.494). The Court of Cassation considered that the agent must provide the principal with complete and regular information on the performance of its duties, failing which it is in breach of its essential obligations.
5. Pitfalls to avoid when terminating a management agreement early:
Performance test:
The performance test is an effective tool for evaluating a hotel’s management. However, the performance test clause must be carefully drafted in the HMA to ensure its legal effectiveness when confronting the operator.
Criteria: Gross Operating Profit (GOP) and/or comparison with similar hotels.
- In practical terms, the agreement should include a performance review clause (periodic review) as well as an independent performance audit. This makes it easier to negotiate an exit with the operator, helping avoid a lengthy and unpredictable dispute.
- Penalties: termination of the HMA, or compensation paid by the operator (“cure payment”). Example: after two years of proven underperformance, the owner of a five-star hotel in Haute-Savoie claimed €175,000 in compensation.
Sale of the hotel:
Owners seek investment liquidity by ensuring that they can sell their hotel or their stake in the company that owns the hotel freely, whether or not the current hotel management agreement is in place. The following should be noted:
- The operator may demand a right of first refusal or scrutiny over the buyer if the operator continues to fulfil the agreement (cf. assignment clause).
- Give preference to a “right of first offer” rather than a strict right of first refusal.
- Avoid excessive contractual compensation – some agreements stipulate up to three years’ fees in the event of an early sale. Tough negotiation can often reduce these amounts.
Control and limitation of the guarantees sought by the operator:
Owners should ensure that any guarantees required by the operator under the agreement are as justified and minimal as possible, since these could reduce the owner’s ability to negotiate an exit or resolve a dispute. Indeed, there are plenty of arguments confirming this.
Termination at will:
The owner may include a clause that allows them to terminate the contract unilaterally and without cause (“termination at will”). This clause is fiercely negotiated and usually comes into force a few years after the agreement takes effect, enabling the owner to withdraw without paying compensation.
However, in most cases, the operator will impose a termination indemnity. For example, in a 15-year contract, we sometimes come across clauses providing for a contractual indemnity of:
- Two years’ fees after seven to ten years of operation
- One year’s fees between ten and 15 years of operation.
In spite of the contractual termination indemnity, an owner may decide to terminate the HMA early or wait until the end of the agreement. If necessary, the owner will negotiate key money with the new operator to finance all or part of the exit.
Termination for misconduct:
- Valid grounds include fraud, gross negligence and failure to comply with obligations relating to the budget and reporting. Regardless of any specific contractual clauses, the owner may invoke breaches of general contract law (French Civil Code).
Even in the absence of specific clauses, the owner may invoke the following:
- Serious breach of contract (Article 1224 of the French Civil Code).
- Loss of trust (Article 1984), although solid evidence is required for this:
- Evidence: Formal notice, audit reports, case law (Paris Court of Appeal, 2012, cited above).
- Exception: it is worth noting the decision of the Court of Cassation (2023), which validated the termination of an agreement without formal notice due to “insulting and contemptuous” behaviour by the other party.
Risk: unfair termination may result in damages being awarded.
Lastly, owners need to master local law, jurisdiction and the language used in hotel managements agreements:
If an owner wants to be efficient, it is best to operate “on home ground” (often the hotel) and become proficient in these subjects, rather than have the operator impose them (something that is rarely mentioned in the term sheet – see our articles on this subject on LinkedIn).
Conclusion, and the approach to follow:
Owners have a certain amount of room for negotiation with each prospective hotel operator who presents a business plan, term sheet and draft HMA. If the operator is motivated, they will generally be eager to explain and corroborate their performance against that of their competitors. They will also look to gain the owner’s confidence by negotiating the appropriate contractual balance best suited to the hotel’s operation.
It is therefore at the term sheet phase that the owner should negotiate the major terms of the HMA and its appendices. Returning repeatedly to key clauses in a poorly negotiated term sheet is likely to alter the dynamics and agenda of management agreement negotiations.
Footnotes
- Hotel management agreements are subject to Articles 1984 et seq. of the Civil Code – see our article published in Option Finance on 30 August 2023: Le contrat de management en France, la flexibilité au service de l’investissement hôtelier.
- REIMS 21.11.2017 – RG 16/01365 – CA PARIS 25ème Ch. Sect. A 4 juin 2004 – AJDI 2004 p.82.
- Ruling handed down by the Paris Court of Appeal on 9 November 2012 (RG 12/12982), upheld by the Court of Cassation on 4 November 2014 (Appeal No. 13-10.494) – see our articles on this subject.
- In our experience as practising solicitors, it should be expected that certain commercial court judges hearing litigation cases may be unfamiliar with these complex contracts, which could result in misinterpretation of the clauses to the owner’s detriment. This underlines the importance of being as precise and exhaustive as possible in hotel management agreements.
- See our article on this subject on LinkedIn: Do hotel management agreements now include too many guarantees?
- Cass. Com. 18.10.2023 – Appeal No. 20-21.579.
- In consultation with advisors and specialist experts who can assist in dealing with the operator’s highly proficient team working on various aspects of hotel management and development.
Christopher Boinet
FR – IE Paris – Avocats
In Extenso Avocats
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