Transcription
Foreign [Music]
Hotel management contracts are what pin down most hotels in Saudi Arabia. Yet, not all hotels, not all HMAs, are well negotiated. The consequences of a bad HMA can make the difference between a happy owner and an unsatisfied one. HMAs are often compared to marriages, actually. While the two are clearly very different, the reason for the comparison is the long-term nature of both and the difficulty in terminating those agreements.
Having worked on over 100 HMAs in Saudi, I've seen what makes a good contract, a normal one, and a bad one. I can tell you that if you implement just the points I will cover today, you can ensure you have an HMA that is very good compared to the market.
So, what does a good HMA from an owner's perspective need to include? I'm going to run through quickly 13 points that are in no way exhaustive, but just 13 good points to keep in mind. If you take those points with you to the next negotiations, you would probably do well in terms of what your HMA looks like.
Number one: having a clear opening date obligation. This means that if you build the hotel according to the standards set, there is no undue delay in opening on the side of the operator. There are clear objective criteria to meet for opening.
Number two: a brand standards freeze. If you have fit out the hotel to the latest standards as of today, there are at least several years within which you're not required to upgrade the hotel.
Number three: signing an operating account threshold. Some owners prefer those, while some do not want to get too involved. These include having a threshold above which the owner has an additional approval right, both in terms of signing operating agreements or withdrawals from the operating accounts or other accounts.
Number four: full budget approval. This is perhaps the most important. When I say full budget approval, I mean approval over the capital budget, the FF&E budget, and the operating budget. Most importantly, once you agree on the budget, there is very limited deviation from it, and those deviations are clearly defined.
Next is understanding all hidden fees. This means that you should not think it's just the management fee, the incentive fee, the central services fee, and the booking fee. You have to work closely with your consultants and the operator to know exactly what fees you will be paying down the line. Many owners are surprised when they first start operations by the amount of fees they are paying, particularly the centralized fees and withholdings. It's important to understand that position. It's obviously good for an owner if it's on the operator, particularly where you are paying those fees or transferring fees offshore.
Number six: staff housing and insurances. This includes deviating from the uniform system of accounts for the region and ensuring that staff housing and insurances, excluding business interruption and property or risk, are included as operating expenses and not as an owner's expense.
Number seven: exclusivity and an area of protection. This is obviously very important, but the extent of such exclusivity will vary depending on the brand and the area. You want to ensure that the circumstances upon which such exclusivity falls away are also clearly defined.
Number eight: key employee selection. This includes, at a minimum, the general manager and the director of finance. You can also include the director of HR, director of sales and marketing, director of engineering—whatever works for you.
Number nine: limited sale restrictions. I want to emphasize here making sure that there are objective criteria so that if there is a sale, the operator is not in a position to unduly delay the sale. If the new buyer meets the requirements, you can easily proceed with the sale.
Number ten: rebuilding upon damage limited to insurances. Most operators require that an owner rebuilds a hotel in the event that it's damaged or destroyed. You want to ensure that the obligation to rebuild is limited to the extent insurances are paid and that it is limited to the extent that the economic situation justifies rebuilding a hotel.
Number eleven: a clear limit or no compensation to an operator in the event of expropriation. While operators will argue that they would have also suffered the loss in the event of expropriation, it's very important that the owner's capital is prioritized in relation to any compensation paid in the event of expropriation.
Finally, number twelve: termination in the event of a prolonged force majeure event. We're particularly seeing this come to light more often nowadays. If the operator is unable to operate the hotel due to a force majeure event, and if that force majeure event is prolonged beyond a period of six months, one year, two years—whatever you reach with the operator—there is the option for the owner to terminate the agreement.
Having touched on what a good contract includes, I will now cover terms that are often considered impossible but are, in fact, possible with the right strategy and a holistic approach to negotiations.
Now, I'm in no way saying that you should go into your next negotiations and fight for the opportunity to make sure you get all these terms. But I am saying that these are terms that are possible and do happen. If you have the right strategy for negotiations and understand the uniqueness of your property and what you bring to the table, then with the right strategy, these are possible.
Number one: key money. We're seeing this more often, especially as competition between operators increases. We are seeing key money from insignificant amounts to significant amounts being paid upfront. You want to ensure that the obligations tied to the key money do not defeat the purpose and that you're not in golden handcuffs once you receive the key money.
Number two: technical services fee refunds. These are also common, whether it's discounts or full refunds upon completion of the hotel.
Number three: shorter terms, aiming at around 15 years, are possible as well.
Number four: targeted GOP, particularly if it's a rebrand and you have a history of operations. Do not feel like you cannot hold the operator accountable or have a targeted GOP amount.
Number five: conversion options. This probably works for some, and some are not interested. This is having the ability to convert a management agreement to a franchise agreement if, after a certain number of years of operations, you feel that you have enough know-how to do so.
Number six: termination upon sale. That kind of speaks for itself.
Number seven: termination for a fee. This speaks for itself but perhaps needs a bit of explanation. It's a rather controversial one, but it does give an owner a lot of leverage in the relationship. Operators will often not accept this because a termination right reduces the overall value of the contract. You need to ensure that you're not negotiating a term just for the sake of having it while suffering on the other commercial terms. If this is a very important term for you, then for the right fee after a certain amount of time, it's not impossible to negotiate.
Number eight: a notional FF&E reserve, whether in full or in part. This means that you don't have to physically transfer the FF&E reserve amount monthly into the account, but you can have it as a notional account. This means that if the operator requires it, then you can pay it. This frees up cash for other amounts and allows you to invest the amount until such time that it is acquired.
Number nine: Saudi governing law and dispute resolution. This is also not impossible. Having a contract governed by Saudi law is always in the owner's interest, and having dispute resolution in the region or locally is also something that is possible.
Lastly, from the not impossibles list, I'd say is a single-pronged or creative performance test. Do not feel that the only performance test you can have is a RevPAR and GOP performance test. RevPAR and GOP performance tests are rarely failed. While they look good to have, you will almost never see an operator fail a double-pronged performance test. So, negotiating and putting time into negotiating a creative performance test—there are a number of interesting ones I've seen in the market—or a single-prong test purely tied to GOP could put you in a really positive position.
Finally, I just want to end with a few takeaways for owners and a few takeaways for operators. This is really speaking from a practical perspective more than a legal one.
For owners, I think it's important to ensure that there's competition between operators. For best results, if you implement a competitive selection process and negotiate LOIs, you can achieve the best results.
Number two: consider engaging consultants at the outset if your team needs support.
Number three: be strategic and make sure you know what you're seeking to achieve from negotiations.
Number four: pick your battles. Pursue the commercially significant issues. You cannot usually achieve everything, so compromise and try to understand the operator's perspective. They are successful international operators for a reason.
Finally, for owners: don't rush the negotiations. The best deals are not usually done fast.
Now, some takeaways for operators as well. I haven't forgotten our dear operators in the room.
Number one, and perhaps a very important one, is to take time to inform and educate. Don't assume that the owner and its consultants know what is distinctive about you as an operator or that they are market experts. You often see owners doing their first hotel. Take the time to explain to them and their consultants how your contract works, what's distinctive about your brand, etc.
Be honest about your strengths and weaknesses with respect to your competitive set. This is very important because no operator is perfect. If you approach an owner from day one, being clear about your weaknesses, particularly, that could lead to a better long-term relationship.
Be flexible. Be prepared to be sufficiently flexible and reasonable to get the right deal done, but remember that different owners require different flexibilities.
Separate the wood from the trees. Don't lose a deal over a word in the indemnity clause. Focus on the bigger picture and the long-term relationship.
Finally, be aware of the local market nuances. Manage egos and respect hierarchies within the organization.
Thank you. [Music]