Trowers & Hamlins senior lawyer Russell Vickers takes a look into the complex world of hotel management agreements and reveals the key points for owners and developers to remember.
The significant number of leisure projects in the Middle East region is creating a boom in the number of hotels being developed. Nowhere is this more obvious than in Dubai, where the Dubailand project alone plans to add a further 80,000 hotel rooms to the emirate's inventory in the coming years.
The three Palm Island developments by Nakheel are also expected to host more than 200 hing and hoteotels.
Naturally, this has led to an ever increasing interest in the region for international hotel operators, particularly with high occupancy rates and high profits per available room. Competition between developers for the appointment of premium hotel operators is increasl operators can now be more choosy about which projects they pursue.
This has allowed premium hotel operators once again to become less flexible on the basis upon which they will undertake operation of a new development.
In addition, the type of hotel management agreement now being used in the region is more sophisticated than in previous years. International-style suites of management agreements are now commonplace.
As the business practices and legal systems in the region mature, so does the need to ensure that arrangements between owners and operators are adequately formalised.
In virtually all situations an operator will have a standard form of management agreement that they will propose to the hotel owner. This would ordinarily be accompanied by at least a pre-opening services agreement, technical services agreement and licence agreement.
It is of course important to ensure that these agreements are tailored for the Middle East market.
It is common for a standard form agreement to be based upon the situation in a western jurisdiction which is often dissimilar to that of the Middle East.
For example, agreements which include references to gambling facilities would be wholly inappropriate, similarly references to alcohol should not be included in agreements covering Saudi Arabia.
Furthermore, employment and immigration laws in the Middle East differ substantially from the position in jurisdictions where there is a more readily available local workforce.
When considering a form of agreement, owners should ensure that they do not focus purely upon negotiating management fees. Full consideration needs to be given to all terms of the agreement.
The more comprehensive a management agreement, the less room remains for a dispute. The issues need to be discussed in an open nature as these will form the basis of the long-term partnership going forward.
The parties should not regard their negotiations in an adversarial manner, but rather one of co-operation. Ultimately, both parties' aims are the same and each want to run the best and most profitable hotel possible.
The fundamental issue, which any owner and operator will often spend more time negotiating than anything else, is their respective levels of control. Both of course have a vested interest in having a broader level of control over the hotel operations.
The key thing to remember here is that hotel management agreements are based on the concept of agency. The operator is appointed by the owner to exclusively manage the hotel on the owner's behalf and in the owner's name.
The owner must not interfere in the operation of the hotel, other than within the boundaries set out in the management agreement.
Nonetheless, rarely nowadays will an owner agree to cede absolute control of a hotel to a hotel operator. The control to be retained by the owner will generally be linked to the annual budgeting process and a right to approve and input into these budgets.
Similarly certain other areas, such as the appointment of key staff and the conduct of material litigation would be carried out with the approval of the owner.
One area where there are often discussions is in relation to the bank accounts of the hotel. Naturally the owner would seek some (and in some cases total) control over these, although generally it is something that should be resisted from the operator's perspective.
Clearly an operator's ability to operate a hotel will be severely undermined if it cannot also operate that hotel's bank accounts on a daily basis.
It is best if the management agreement specifies who has the right to be an authorised signatory and particularly whether the owner expects some co-signing rights. Such co-signing rights should ordinarily only be relevant for unbudgeted expenditure over a certain level.
Less management control for the operator means it has less influence on the hotel's gross operating profit. The more rights retained by an owner means the operator is less in control of the maximisation of profits and corresponding incentive fee due to itself.
These issues should be considered when setting a base fee, although many owners and operators will seek to agree a fee before turning to the broader nature of the relationship.
The hotel sector in the Middle East is developing at a rapid rate and there is certainly no standard way of doing business.
In Dubai, the fact that the QE2 liner will be permanently moored in the emirate as a floating hotel from 2009 shows the desire to make hotels stand out and yet, with seven-star hotels already in place, it clearly takes more than luxury to stand out.
The development of theme parks in Dubailand and Jebel Ali will also add to the demand and growth of the tourism industry. Some of the new developments that will further shape the leisure sector in the region are listed below.
Regional hotel operators: The major international hotel operators have been present in the region for many years, and in recent years their foothold has been cemented further.
However, at the same time, regional hotel operators such as Rotana and Jumeirah have first established and then consolidated themselves as serious players in the wider Middle East and the international market respectively.
Other regional examples include Emirates, which is growing its hotel portfolio and Emaar, which is seeking to operate a number of the hotels which it is developing.
These regional operators approach their hotel management agreements with differing levels of sophistication.
If new entrants to the hotel sector want to be taken seriously, they would be wise to develop standard agreements along international best practices.
Fractional ownership: The introduction of a strata title law in Dubai has meant that a large number of projects are now looking at being operated on a fractional ownership basis.
Even where a hotel is not itself in factional ownership, but parts of that building have been sold off separately, for example as residential apartments, this in turn can lead to there being a building association with which the operator will also need to enter into a contractual relationship.
The trend of fractional ownership is expected to continue across the region. Management agreements are becoming more sophisticated to reflect the creative structures that hotel developers are putting in place.
These arrangements need to be carefully scrutinised by hotel operators to ensure that while the individual unitholders may participate in any profits generated by that hotel, they should generally have little in the way of other rights relating to the operation of that hotel.
The lack of regulation in relation to the marketing of such projects means that some unitholders might be buying these properties on the basis of unfeasible financial models. If their expectations are not met, it may in turn reflect badly upon the operator.
Timeshare: The concept of timeshare is anticipated to become the next big thing in the region, with a timeshare law expected to be passed shortly. This can present unique challenges to both owners and operators in formalising agreements where the legal framework remains unknown. Nonetheless, the first timeshares in Dubai have already opened their doors and more are likely to follow.
Sharia compliant hotels: A growth area in the Gulf region is the prospect for hotel operators and owners to operate on a Shari'a compliant basis. In these cases, careful consideration needs to be given to provisions of the management agreement as well as the facilities that can be offered at the hotel - for example serving alcohol, and mixed-use leisure facilities.
Operators need to bear these in mind when looking at their standard business operations and whether these issues would affect their financial projections for a hotel.
Budget hotels: The budget hotel sector is also expected to take off. Long have the super-luxury hotels been the mainstay of the hotel market, but now in an effort to broaden the customer base and fill an obvious gap in the market, leading budget hotel brands are seriously looking at the region.
At the same time the development of mid-level hotels is gaining pace. International hotel operators, who have long operated full-service properties in the region, are actively looking at bringing their select service brands to the Middle East.
Eyes wide open
The opening up of the real estate market in the region has led to a much wider number of owners developing hotels. This, together with a boom in tourism, particularly in Dubai, has led to many new operators entering the market.
Establishing a hotel and entering into a management agreement is a long-term relationship for both owner and operator. It is in both parties' interest to ensure that the basis of their arrangements is fair and clear.
Rushing into a relationship without giving proper thought to the long-term nature of it and the potential pitfalls is dangerous. Addressing as many issues as possible in advance, is fundamentally important to ensure each owner and operator is fully aware of the nature of their joint venture.
In doing so, the future success of the business relationship can be effectively safeguarded.
Trowers & Hamlin's Dubai office offers a full range of legal service to hotel owners and operators in the Middle East and the UK and acts for a number of leading developers and international operators. Visit
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