2 March 2010
Bombings and attacks on hotels in India, Indonesia and elsewhere are major concerns for hotel owners and operators alike. Quite apart from the obvious primary concern for staff and guest safety, terrorist events outside the control of an owner or operator present significant issues of risk allocation for both parties under hotel management agreements. This note identifies those provisions in hotel management agreements to which both owners and operators should pay particular attention when negotiating agreements in today's environment.
There needs to be legal certainty and fairness in how risk is apportioned between owner and operator. This particularly applies to significant provisions that deal with repair and restoration of the hotel, appropriation or forced alteration of a hotel, force majeure, guest liability, and insurance.
Repair and restoration of a hotel
Where a terrorist event has significantly damaged a hotel, one of the key questions a hotel owner will likely ask is, "Should I restore my damaged hotel or would it be better to start afresh with an entirely new class or even new type of property?" He or she may, however, be contractually bound to the operator to reinstate the hotel and accordingly have no opportunity to exercise his preference.
Under a management agreement the obligation on the owner to reinstate the hotel usually depends on the extent of the damage. Only if the costs of repair exceed a specified threshold, will the owner have the right to terminate the management agreement without payment of compensation to the operator and start again.
What is useful from an owner's perspective is to have another, lower, threshold which is applicable when the damage is not covered by insurance. The determination of both thresholds is a matter for the owner and operator to negotiate. The thresholds are usually defined by reference to the cost of repair and the expected duration of the repair works. Clearly having a low threshold, particularly for damage not covered by insurance, is very important for every owner. From an owner's perspective, it would be ideal if the owner has the discretion to decide whether to undertake the repair works based on whether it is economically feasible to do so. However, from an operator's perspective, there should be an objective threshold determining whether owner should repair the hotel.
If an owner does not repair and restore the hotel and the hotel management agreement is therefore terminated, there are two further issues worth considering: firstly, who is entitled to the insurance proceeds (if any), and secondly, whether the operator should have a right of reinstatement if the owner rebuilds a hotel after termination. An operator would argue that the insurance proceeds should be shared equitably between the parties, while an owner would argue that priority should be given to the owner's recovery of its investment. It is quite common for the operator to have a right of reinstatement if the owner rebuilds a hotel of similar class and standard within 2 or 3 years after termination, but this period should not be too long.
In some cases, operators even ask for payment of compensation from the owner in the event of such termination. Owners often try to resist this or at least try to limit the amount of compensation payable to the operator by the amount of insurance proceeds recovered by the owner that represents operator's loss of income for business interruption.
Appropriation and forced alteration of a hotel
Although not directly relevant to terrorist events, there is always a possibility that a hotel becomes appropriated by a government or an army. In such a situation, an owner will generally have the right to terminate the management agreement without payment of compensation to the operator if the hotel is taken for a long period of time, often 12 months.
If the length of “appropriation” is shorter than the specified period, the owner will normally be obliged to repair and reinstate the hotel after the “appropriation” unless there is an excessive cost of repair, as discussed above.
There is also a question as to whether the term of the contract should be extended in such circumstances by the period of "appropriation".
In Hangzhou, China, there were reports that the local authorities might impose an order on the Shangri-La to remove the top few stories of its hotel to meet new height restrictions as part of Hangzhou's drive to attain UNESCO heritage status.
This would amount to a partial appropriation and should also be dealt with in the management agreement by providing a right to terminate if the appropriation makes it commercially or practically impossible to operate the remaining portion of the hotel as a hotel of the same class and standard.
The issue of who is entitled to any appropriation awards should also be considered. The principles discussed above in respect of entitlement to insurance proceeds for repair and restoration of a hotel apply to this issue.
Force majeure may be regarded by some as a boring boilerplate provision. Yet in the aftermath of a terrorist attack (or other major incident) it can become key to the operation of the whole agreement.
Following a terrorist attack, hotels in a city, country or even region may experience difficult trading conditions. Hotel operators may well struggle to meet their performance tests. Whether this will trigger performance termination will depend on how the force majeure clause is drafted.
Equally there may be hotel operators who continue to miss performance targets well after recovery. From an owner's perspective, it will be important that such an operator is not able to use a force majeure clause to excuse poor performance. From an operator's perspective, it is critical that it does not fail the performance test for reasons unrelated to its performance and that are not within its control.
Force majeure provisions might be used by either owner or operator and drafting need not favour one or the other. It is, however, important to ensure that there is complete clarity on what is included and when it will apply.
Liability towards guests
Hotel guests who are victims of terrorist attacks may bring claims of negligence against hotels which have suffered such attacks but, who is responsible for such claims, particularly where there is a gap in insurance coverage?
Hotel ownership will always involve the assumption of risk in relation to large personal injury claims. This liability may be direct. The operator will usually insist that the owner indemnifies them for most, if not all, risks.
Given the extent of possible claims, owners are advised to ensure they negotiate indemnity clauses so that these are fairly balanced with reasonable carve-outs of the indemnity they give operators and ideally with some form of reciprocal indemnity from the operator to the owner. Indemnities in relation to the negligence of the general manager and other key staff are particularly worth arguing for (although these are usually capped).
It is also preferable that owner and operator work together to ensure that reasonable care standards are met. This may include implementing appropriate security policies, providing crisis management training to all employees and regular reviews of how the hotel itself may be made more secure.
Where there is a terrorist attack, the question of terrorism insurance becomes fundamental.
Owners are advised to consult their insurance brokers at an early stage and to explore the availability of terrorism insurance for the relevant market. Terrorism is typically excluded from most insurance policies, but in limited cases, may be written into the policy for an additional premium. In the absence of terrorist insurance, liabilities are likely to be borne entirely by the owner unless the hotel is located in a country where the government will step in to meet liabilities or provide other financial support.
In deciding the type and extent of insurance necessary it is always useful for the owner and operator to work together with their respective insurance brokers to agree on common ground. During the negotiation of management agreements, key issues often include who bears the cost of the insurance, what happens if one party invalidates the insurance and the consequences if a specific type of insurance is not available in a particular market.
Increasingly, hotels seem to be the unlikely victim of many events outside the control of both owner and operator. Although the likelihood that the above provisions are triggered is relatively small, the economic impact on owners and operators is great. A fair and well thought out management agreement needs to provide protection for the interests of both parties and to provide sufficient clarity to
help both parties in the aftermath of such events.