Management Agreement

The hotel management agreement has been universally recognized as a tool that links the operators of a hotel with the investors who desire to own hotels. However, the lease agreement has been popular since ages even before the management agreement came into existence. The management agreement witnessed popularity during late 1950’s. Nowadays, majority of the hotels in the world are operated under this agreement and the similar issues remain pertaining to the negotiation between the owner and the operator. One of the earliest example of such agreement is Hong Kong Hilton. This hotel was owned by Hutchison Whampoa (a Hong Kong company) while Hilton International (a US based company) was the management company for Hutchison Whampoa after these two companies entered into a management agreement. However, with the passage of time, the agreement became more complex. These complexities are usually due to the increase in the intensity of bargaining, stringent regulatory requirements and emergence of lawyer- centric society. 

Management agreement is an agreement between the owner and the operator of a business (Turner 2013). Hotel management agreement is the agreement between the owner of the hotel and a person or group of persons or a company that shall operate the business. The operator is responsible for handling the routine working of the business such as managing front office, maintaining the hotel, managing food and beverages, housekeeping and finally ensuring sales. The management agreement person or group of persons or the company shall have the power of recruiting and firing the employees (Jayawardena et al. 2013). The owner shall be the authorized person and shall only be responsible for arranging the capital for the hotel business whereas, the operator shall be responsible for managing all the business operations. However, these agreements are very complicated and lengthy (Turner, Hodari and Blal 2016). The agreement focuses mainly on the owner’s powers and the operator’s rights. The prospective operator usually offers the initial draft and is biased towards the operator such that they can enter into long- term agreements. The agreement prohibits any interference of the owner and on the contrary, it demands regular supply of investment from the owner for the growth and expansion of the business.

The major purpose of this agreement is to help the investors who have capital amount for investing in a hotel business but do not possess the knowledge and ability to operate the business (Freedman and Kosová 2014). There are several businesspersons, who have sufficient finance to start a business but they lack the essential expertise. Therefore, this agreement provides them with the assistance of management companies that can efficiently convert the investment into outputs.

The major elements of the hotel management agreements are as follows:

• Several terms and conditions
• Tenure of the agreement
• Early termination process by either party
• Fixed assets of the hotel
• Insurance policies of the hotel
• Investment required by the management company
• Terms in case of sale of the hotel
• Fees related to performance of operations
• Terms of penalties
• Employee’s status

A lease agreement is a contractual arrangement that calls for the user known as the lessee to pay the owner known as lessor for using an asset (Ivanova and Ivanov 2015). The lessor is the legal owner of the asset while the lessee seeks the right to use the asset by paying regular rent. The lessee is required to abide by the conditions laid by the lessor regarding the use of the asset (Liu, Quan and Ukhov 2014). In case of a hotel lease agreement, there is contractual arrangement between the owner of a property and the hotel operators that permits the hotel operators to conduct their business operations in the lessor’s property by paying monthly rent.  The major purpose of lease agreement is to allow the businesspersons with insufficient capital to start their business operations without investing in infrastructure (Lehr 2015).

Lease Agreement

The major elements of a lease agreement are as follows:

• Names of the parties to agreement
• Duration of the agreement and the starting date
• Identifies the specific object being leased
• Renewal as well as non- renewal conditions
• Payment conditions
• Payment provisions of security deposit and provisions of return
• List of conditions  and remedies
• The specific conditions placed upon parties relating to insurance, restrictive use and maintenance responsibility
• Termination clause (Weber 2014)

The hotel industry has witnessed huge growth in the past few decades in the Middle East countries. Several international operators have been successful in running profitable businesses in the Middle East countries. However, these countries have put several restrictions on the international investors on the ownership of real estate. As a result, only a few hotels are owned by the operators in these countries. This has encouraged the local companies to enter into management agreements with the operators (Niewiadomski 2014). The uniqueness of the hotel management agreement is that it can be easily negotiated according to the bargaining power of the parties. Most of the operators nowadays prefer hotel management agreement on their standard form of agreements for the success that they would bring to the hotel project by applying their knowledge and experiences. Most of the operators have developed their own in house legal capabilities while on the contrary, the owners witness a distinct experience and knowledge gap.

The hotel management agreement also requires various other ancillary contracts namely Technical services agreement, Central services agreement, IP license agreement and Non-disturbance agreement. The Technical service agreement is required when the operators provide some technical consultancy services to the owners for some fees. The Central services agreement governs the additional hospitality services provided by the operators. IP license agreement is useful when the owner uses the brand of the operators. Finally, the Non-disturbance agreement is required to prevent any interference of the financer in the operations of the hotel business. This is basically required when the owners seek additional finance for the growth and development of the business.

The hotel management agreement is used when the owners aim at achieving profits as a result of the expertise and knowledge of the operators for the successfully running the hotel business. In return of the expertise and knowledge provided, the operator charges a fees that might include basic fees for managing the operations, incentive fees, license fees and fees related to additional hospitality services provided.

At the beginning of the hotel management agreement, the owner and the operator decide an operating budget that would include the expenses and revenues of the forthcoming year. For this purpose an operating account and a furniture, fixture and equipment account is opened. The revenues generated from the business processes go in the operating account that covers the operating expenses. The operator is usually allowed to use the operating account for payment of the expenses or else in accordance with the hotel management agreement. The operator is also required to maintain certain amount in the furniture, fixture and equipment account in order to cover the replacement and substitution expenses. Owner is usually responsible to undertake any repairs related to the structure of the hotel or repairs of capital nature. It is the legal obligation of the operator to remit any remaining funds in the operating account to the owner of the hotel. The provisions in the hotel management agreement also specify the calculation and payment of fees to the management company. Earlier the fees structure was known as “three plus ten” in which the operator was paid 3% of the revenue generated and 10% of the profits. However, a enhanced risk and reward alignment was introduced in the hotel management agreement to encourage the operators to efficiently use their expertise and knowledge for generating profits out of the hotel business.

Hotel Management Agreement in Middle East

Satisfaction of the customers and shareholders is the major aim of the companies in hospitality sector. A satisfied customer is a loyal customer of a company and satisfied shareholders help the company in raising capital. Hotel management agreement helps the owners of the hotels to efficiently conduct their business operations by utilizing the expertise and knowledge of the management companies (Melissen, van Ginneken and Wood 2016). There is always a possibility that the actual owners do not possess the skills and abilities required to successfully carry out the business operations that might result in losses. Therefore, assigning the responsibility of managing the business operations to some expert management company increases the chances of profits. Often it has been observed that a single owner has several businesses in different locations or countries. This makes it impossible for the owner to operate the businesses himself. Therefore, the need of a managing company arises that can manage the operations of the business in the absence of the owner. The management of the hotel by a expert management company ensures the shareholders of the profits. This makes the shareholders feel more secured about the efficiency of the company and they are assured that they shall be benefitted by buying the shares of the company (Lee et al. 2014). The shareholders are also assured that they shall be paid dividends out of the surplus earned by the company. Therefore, the hotel management agreement provides better security to the shareholders as they are ensured of the profitability of the business.

Entering into a hotel management agreement involves giving up some privacy and confidentiality as the owners hand over the business to the management company. The company may also increase the employee turnover. There are high chances that there are conflicts between the owner and the operator. Several conflicts might arise related to the discounts, price changes, suppliers, accounting and handling of pay roll (de Souza et al. 2016). These conflicts might have adverse impact on the functioning of the business as well as might damage the brand image of the company. All these circumstances pose severe risk to the profitability of the business, which indirectly affects the dividend payment of the shareholders. In case of losses incurred due to conflicts, the shareholders shall not be paid the dividends and the share value of the shares of the company also fall and the shareholders suffer losses on the shares purchased

 Shareholders are highly affected by the profitability or loss of the company in which they have invested. Profitability of a company ensures payment of dividend and an increase in the price of their shares whereas losses incurred by a company results in fall in the prices of shares as well as non-payment of dividends. The several advantages of lease agreement that prove to be beneficial for the shareholders are:

• Efficient use of capital: Lease agreement enables the owners of hotels to save capital as they are no longer required to purchase property. This allows them to invest the capital in other capital needs of the business. Therefore, lease agreement helps in efficient use of the available capital.
• Tax benefits: Lease payments are the operating expenses for a business that provides tax benefits to the owners of the hotels. These tax benefits result in an increase in the profits of the company, which in turn ensures the payment of dividend to the shareholders (Kruesi, Kim and Hemmington 2017).
• Balanced cash flow: The major advantage of lease agreement is that the lease payments are distributed over several years that reduces the burden of single time payment. Therefore, the lease agreement helps the owners to maintain balanced cash flows that leads to steady and profitable business.
• Quality assets: The shareholders are assured about the quality of the assets of the company as the ownership still lies with the lessor (Salvioni 2016).
• Better planning: The payment of lease remains constant throughout the tenure of the lease agreement that allows the owners to plan their activities accordingly. Therefore, lease agreements lead to better planning which further leads to efficiency and profitability and profitability further improves the condition of the shareholders (Lee, Huh and Lee 2015).
• Reduced risk of obsolescence: The lease agreement helps the owners in saving capital to be invested in infrastructure. This enables the owners to utilize their saved capital by investing in latest technology in order to enhance the business operations. The increase in the efficiency of the business would render profits to the shareholders as well.
• Lower capital expenditure: Leasing helps the new entrepreneurs in saving costs of initial set up. The reduction in the capital expenditure helps the businesspersons to invest more in the variable costs that would increase the efficiency of the business.

Several disadvantages of lease agreement adversely affect the shareholders. The disadvantages are as follows:

• Reduced financial benefits: Since the businesspersons pay rent for using a property instead of purchasing the property, the businesspersons are unable to obtain benefits from the appreciation of property’s value. The lease becomes a burden on the businesspersons as the tenure of the agreement is fixed and so are the expenses over several years.
• Reduction in the return for equity shareholders: There is a sharp decline in the net income due to the payment of lease. Additionally, there is no value appreciation that reduces the returns for the equity shareholders. Therefore, the business is unable to maximize the wealth for the shareholders (Marantz 2015).
• Debt: The investors wrongly consider lease payments as debt and adjust the business valuation accordingly. However, lease payment is not an item of balance sheet and should not be considered as debt. Wrong balance sheet shows wrong financial position of a business that adversely affects the shareholders.

Conclusion:

Therefore, it can be concluded that hotel management agreement is the agreement between the owner of the hotel and a person or group of persons or a company that shall operate the business whereas lease agreement is a contractual arrangement that calls for the user (known as the lessee) to pay the owner (known as lessor) for using an asset. Satisfaction of the customers and shareholders is the major aim of the companies in hospitality sector. A satisfied customer is a loyal customer of a company and satisfied shareholders help the company in raising capital. The hotel industry has witnessed huge growth in the past few decades in the Middle East countries. Several international operators have been successful in running profitable businesses in the Middle East countries. However, these countries have put several restrictions on the international investors on the ownership of real estate. This has encouraged the local companies to enter into management agreements with the operators. Most of the operators nowadays prefer hotel management agreement on their standard form of agreements for the success that they would bring to the hotel project by applying their knowledge and experiences.  Both the hotel management agreement and lease agreement has certain advantages and disadvantages that affect the shareholders. Therefore, the owners must wisely choose amongst the two while keeping into consideration the interests of the shareholders.

References:

de Souza, A.G., Salazar, V.S., Leite, Y.P. and Ivanova, M., 2016. entry modes: lease contract. The Routledge Handbook of Hotel Chain Management, p.185.

Freedman, M. and Kosová, R., 2014. Agency and compensation: Evidence from the hotel industry. Journal of Law, Economics, and Organization, 30(1), pp.72-103.

Gannon, J.M., Roper, A. and Doherty, L., 2015. Strategic human resource management: Insights from the international hotel industry. International Journal of Hospitality Management, 47, pp.65-75.

Ivanova, M. and Ivanov, S., 2015. Affiliation to hotel chains: Hotels’ perspective. Tourism Management Perspectives, 16, pp.148-162.

Jayawardena, C., McMillan, D., Pantin, D., Taller, M. and Willie, P., 2013. Trends in the international hotel industry. Worldwide Hospitality and Tourism Themes, 5(2), pp.151-163.

Kruesi, M., Kim, P.B. and Hemmington, N., 2017. Evaluating foreign market entry mode theories from a hotel industry perspective. International Journal of Hospitality Management, 62, pp.88-100.

Lee, M.J., Huh, C. and Lee, J.Y., 2015. Business Cycle and Long-Term Debt: Effects on Hotel Operating Lease. The Journal of Hospitality Financial Management, 23(2), pp.138-146.

Lee, S., Upneja, A., Özdemir, Ö. and Sun, K.A., 2014. A synergy effect of internationalization and firm size on performance: US hotel industry. International Journal of Contemporary Hospitality Management, 26(1), pp.35-49.

Lehr, D.D., 2015. An analysis of the changing competitive landscape in the hotel industry regarding Airbnb.

Liu, C., Quan, D. and Ukhov, A., 2014. The dynamics of credit spreads in hotel mortgages and signaling implications. Journal of Real Estate Research.

Marantz, N.J., 2015. What do community benefits agreements deliver? Evidence from Los Angeles. Journal of the American Planning Association, 81(4), pp.251-267.

Melissen, F., van Ginneken, R. and Wood, R.C., 2016. Sustainability challenges and opportunities arising from the owner-operator split in hotels. International Journal of Hospitality Management, 54, pp.35-42.

Niewiadomski, P., 2014. Towards an economic-geographical approach to the globalisation of the hotel industry. Tourism Geographies, 16(1), pp.48-67.

Salvioni, D.M., 2016. Hotel Chains and the Sharing Economy in Global Tourism. Symphonya, (1), p.31.

Turner, M.J., 2013. Hotel Management Contracts: a Particularly Rich Research Context. J Hotel Bus Manage, 3, p.e107.

Turner, M.J., Hodari, D. and Blal, I., 2016. Entry modes: management contract. The Routledge Handbook of Hotel Chain Management, p.157.

Weber, T.A., 2014. Intermediation in a sharing economy: insurance, moral hazard, and rent extraction. Journal of Management Information Systems, 31(3), pp.35-71