Countries worldwide are attempting to kick-start their economies after extensive lockdown periods during which hotels have either been forced to close or have continued to operate but with staggeringly low occupancy rates. As governments look to revitalize their bruised and battered hotel sectors, the team at Bryan Cave Leighton Paisner look at a few of the practical considerations facing hotel owners and operators as they navigate the re-opening of their hotels within the confines of their hotel management agreements (HMAs).
When should we re-open?
Any decision to re-open should be based on a cost benefit analysis that establishes the minimum occupancy rate and average daily rate required to financially justify resuming hotel operations. Owners and operators should set target re-opening dates, even if these dates are merely projected at this stage, as this will help them to revise budgets and prepare sales and marketing plans accordingly so that the hotel is ready when the market starts to open up again.
Who decides when to do the hotel re-opening – the owner or the operator?
The typical position under an HMA is for the operator to decide when to close and re-open the hotel, as they are operationally in control and need to be able to ensure the safety and security of guests and hotel employees (and also to preserve their brand standards).
Some HMAs include a specific clause giving the operator this right. Otherwise, it is often dealt with in other more boilerplate provisions such as the force majeure clause or the casualty and condemnation clauses. Occasionally an HMA will enable the owner to have more of a say in relation to closure, however, these are very much the exception rather than the rule.
If the HMA is silent on closure and re-opening, it is likely to be the operator who decides. Again, this is because they are operationally in control of the hotel and they will require operations to resume once the hotel can operate to their brand standards. An owner looking to re-open their hotel should discuss the re-opening process in detail with their operator. Often the operator will have a re-opening checklist in place which must be complied with before the operator will agree to re-open.
Compliance with brand standards
Any new COVID-19 related procedures are likely to form part of the operator’s brand standards going forward. Under an HMA, the owner is likely to have a general obligation to ensure that the hotel complies with brand standards at all times, so the owner will almost certainly have to implement any changes requested by the operator. Furthermore, expenditure on brand standard compliance is often a carve-out from the owner’s budget approval, meaning that the owner may have little oversight regarding any costs associated with implementing any updated brand standards.
Some owners may have negotiated a freeze period during which the owner is not obliged to implement any changes to brand standards. However, brand standard compliance freezes typically exclude “critical” brand standards, which can include brand standards relating to health and safety. If this is the case, the owner may not be able to use the freeze period to avoid having to implement any COVID-19 related changes requested by the operator.
In any event, it is almost certainly in the owner’s interest to implement these changes to ensure a safe working environment for hotel employees and to attract guests back for hotel re-opening.
Annual budgets for 2020 will inevitably have to be revised, as no one could have anticipated the effect that COVID-19 would have on the hotel sector when they were prepared. Some HMAs provide for the annual budget to be revised during the year, adopting a similar owner approval mechanism to the main budgeting process at the end of each year. However, this is uncommon and most HMAs only cover preparation and approval of the annual budget at the start of each year. Regardless of whether the HMA includes such a provision, the owner and the operator will have to reconsider this year’s annual budget and try to agree sensible targets for the rest of 2020.
HMAs typically include an emergency expenditures clause that allows the operator to incur expenditure without the owner’s approval if necessary to address imminent threats to life, safety or property. Operators may look to invoke this clause if they need to incur additional unbudgeted expenditure dealing with COVID-19. Owners should review their HMAs to ensure accountability for this expenditure – operators should be obliged to notify owners of the expenditure as soon as reasonably practicable after it is incurred together with a reasonable explanation of the expenditure and why it had to be incurred.
Is this the right time to use the FF&E reserve for other purposes?
The furniture, fixtures and equipment (FF&E) reserve is built up by monthly contributions from gross revenues. If the hotel is closed or operating at low occupancy, the FF&E reserve may not actually have any funds available in it. If there are funds available, it makes sense to utilise them for other more pressing purposes, such as payroll, particularly if liquidity is tight at the moment.
However, the FF&E reserve is usually only permitted for use for repairs and replacements of FF&E. If the owner wants to unlock it for other purposes, the operator’s approval would be needed, as this would be a departure from the terms of the HMA. Operators are also likely to require the owner to replenish the FF&E reserve once liquidity improves.
The owner should also check the terms of its financing. Lenders will take security over the hotel’s bank accounts, including the FF&E reserve, and will generally not permit funds in the FF&E reserve to be used for any purpose other than permitted under the HMA. The owner will therefore also have to get consent from its lender before it can unlock this fund for other purposes.