8 Things to Negotiate in Your Next Franchise Agreement
By Robert E. Braun, Bob Braun is a Senior Member of JMBM’s Global Hospitality Group®
The ascendancy of hotel franchise agreements.
landscape. Hotel management agreements are not dead, but the advantages of having a hotel operator independent of the brand have been widely recognized and continue to propel the franchise model. (The considerations of branding and using branded (versus independent) management are discussed at length in "When should you choose a brand for your hotel? And when should the brand manage your hotel?")
What's really negotiable in a franchise agreement?
The most common question we hear from clients is, "What's really negotiable in afranchise agreement?"
Franchisees are told by the brand that the franchise agreements are not negotiable, butthen they hear that someone has been able to negotiate at least one or two contract terms. Potential franchisees don't want to waste time, but the contracts seem so one- sided, and they want to get as much substantive relief as they can.
Based on our experience with hundreds of hotel franchise agreements, JMBM's GlobalHospitality Group® knows that there is plenty of wiggle room to get some important concessions if you know what to go for and don't waste your effort where it won't do any good.
One of the biggest mistakes we see is owners trying to negotiate the franchise termsthemselves. Their lack of experience shows that they are amateurs, and the brands quickly realize that they don't have to give much by way of concession.
While we don't recommend negotiating your franchise agreement without anexperienced advisor, hotel lawyer Bob Braun has laid out a few areas where we have been able to help owners improve their contract terms. Depending upon your circumstances, there may be significant other opportunities.
Hotel Franchise Agreements:
8 Things To Negotiate In Your Next Franchise Agreement | B
Robert E. Braun | Hotel Lawyer
Most branded hotel properties are operated under franchise agreements which are longdocuments with lots of fine print. They are usually presented to owners as "non- negotiable." This brand position is justified on the basis of need for uniformity in agreements and insuring that hotel guests will have a consistency of amenities, operations and experience in all hotels bearing the same flag.
However, hotel owners seeking a franchise also have legitimate interests, and thereneeds to be some recognition of these needs and the unique circumstances of every situation. In fact, our experience shows that, within certain limits, key provisions of these franchise agreements can be negotiated to be more favorable to the franchisee. Franchise agreements are not nearly as negotiable as hotel management agreements, so owners are well advised to understand what can and cannot be negotiated in order to realize the greatest value from their relationship with the brand.
We have negotiated hundreds of franchise agreements with every major traditionalbrand (and most of the others), and based on our experience, we believe there are key franchise agreement terms that hotel owners should normally be able to accomplish.
Here are 8 of the most common franchise terms we are seeing negotiated today:
1. Franchise and Royalty Fees
While it's unlikely that franchise fees will be reduced for the entire term of theagreement, a "ramp up" in fees over the initial years of the agreement, particularly for a newly built hotel, can often be achieved. While other chain fees are more difficult to negotiate, it can be possible to get some temporary relief there as well.
2. Area of Protection or Non-Competition
Hotel owners are properly concerned about the brand opening a competing hotel withintheir property's market area. If it's not offered, a franchisee should ask during the negotiations for a geographic area of protection or non-competition. The length and breadth of the restriction varies, but some protection is usually granted.
3. Ownership Transfer
Most franchise agreements are still based on a simple ownership model, contemplatinga single owner (or investment group) of a single hotel. Our experience is that more complicated owners (including REITs, private equity groups, real estate funds and other institutional investors) are increasingly focused on hotel investments. As a result, the transfer provisions should consider the structure of the owner and flexibility for transfers to certain related parties. In that regard, while a sale of a hotel often precipitates a property improvement plan or PIP, the owners should not trigger a new franchise agreement negotiation, set of franchise application fees and PIP when the transfer is to a related corporate entity or to another family member or trust set up for estate planning purposes.
4. Independent Management and Changes inManagement
The essence of franchise structure is providing the power of a brand with the greaterflexibility and responsiveness of an independent operator (i.e. an operator unrelated to the brand). A good independent operator can provide an owner with a valuable buffer to the brand's demands for operating and capital expenditures, implementation of new and expensive brand standards, property improvement plans, and certain brand programs that may not make sense for a given property. While brands are, understandably, concerned that an operator must have the experience to run the property, the management company should be the owner's choice, and should have primary loyalty to the owner, not the brand. Thus, it's important to prevent a franchisor from having veto power over change in management of the hotel.
5. Liquidated Damages
Liquidated damage provisions in the franchise agreement give the franchisor the abilityto collect damages on the early termination of the franchise agreement. They can be a key inhibitor to the owner's ability to maximize the value of the property on sale, because liquidated damages have ballooned in recent years to as much as five times the average combined franchise fees and reimbursements paid to the franchisor. There are usually ways to both reduce the amount of the damages as well as restrict the potential transactions that might trigger payment.
6. Capital Investments
Franchise agreements usually give the brands the ability to require substantialadditional capital investments by owners to meet new physical brand requirements. There are a number of ways to reduce an owner's exposure, including restricting time periods and clarifying the types of capital improvements that can be required. This is particularly the case for a newly built property or an acquired property that may have recently undergone renovation.
7. Personal Guarantees
Most franchisors require guarantees. Owners should seek to eliminate, or at leastrestrict the scope, of guarantees. As more and more owners are institutional, this requirement is less and less meaningful.
8. Key Money
For the last several years, many brands have been willing to provide key money as ameans of securing franchise agreements. While owners are typically excited about the prospect of getting additional funds, they should remember two things: First, key money is typically only paid after the hotel opens; it doesn't provide funds for construction. Second, and more importantly, key money is probably the most expensive money an owner will get; in return for key money, brands typically will be even less willing to negotiate important franchise agreement provisions.
While there are limited areas that an owner can expect to successfully negotiate with abrand in a franchise agreement, changes in these limited areas can make a big difference in the value of the brand to the owner. Our expertise in understanding how to implement these changes, and what other changes might be appropriate in a particular circumstance, has achieved significant value for our clients.
Robert Braun is a senior member of the Global Hospitality Group® atJMBM. Mr. Braun advises hospitality clients with respect to hotel management agreements, franchise agreements and operating issues. He also advises on transactional matters, including entity formation, financing, and joint ventures, and works with companies on their data technology, privacy and security matters. These include software licensing, cloud computing, e-commerce, data processing and outsourcing agreements for the hospitality industry. He is a member of the International Association of Privacy Professionals. Contact him at 310.785.5331 or firstname.lastname@example.org.
The right hotel brand and management agreement can be the difference betweensuccess and failure of a hotel. The Global Hospitality Group® at Jeffer Mangels Butler & Mitchell LLP has negotiated, renegotiated, litigated and advised on more than 1,000 hotel management and franchise agreements all over the world. To see how we help clients in this arena, please click here to see our brochure.
We also have a rich library of free resources available on most topics of interest topeople dealing with hotels. These are all available at www.HotelLawyer.com. This is where you will find our free handbooks under the "Resource Center" tab.
For blog articles, scroll down any page of HotelLawyer.com and look on the right side forTopics that appear in red letters. For example, you can see all the blog articles on "Hotel Franchise & License Agreements" by clicking that link. The same goes for "Hotel Management Agreements" or any other subject you see listed down the right hand side of HotelLawyer.com.
The following are only a few of the relevant blog articles you will find there:
- When should you choose a brand for your hotel? And when should the brand manage your hotel?
- Dual-branded hotels – What every owner or developer should know
- Hotel Lawyer on Repositioning: The New York Times reports 39 percent increase in reflagging
- The 5 questions every owner should ask before selecting a hotel brand
- The HMA Handbook (2nd edition), Hotel Management Agreements for Owners, Developers, Investors & Lenders
- Checklist for negotiating Hotel Management Agreements/Hotel Operating Agreements - The HMA PRO™ Checklist
- Hotel Lawyer with insights on "How to get a great hotel operator"
- How to get the right hotel operator
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JMBM"s Taxation, Trusts & Estates Group is one of the largest and most active groups of its kind within a full-service law firm. Recognized by U.S. News & World Report / Best Law Firms® with a First-Tier ranking in the Los Angeles metropolitan area, our practice focuses on the needs of individuals and families, and their business interests. Our attorneys provide estate planning, wealth transfer planning, trust administration and the resolution of trust disputes. Our tax lawyers understand business concerns, and work closely with colleagues in the Firm"s corporate and real estate groups to ensure the tax efficiency of organizational and transactional decisions.
JMBM's Global Hospitality Group® provides business and legal advice to hotel owners, developers and investors, based on practical experience gained from more than $71 billion of hotel transactions, 1,000 hotel management agreements, 1,000 franchise agreements, and 3,800 properties worldwide. The Chinese Investment Group™ within the practice is a dedicated team of hotel and real estate lawyers that provide a gateway for Chinese investment in the United States. The Group and its network of reliable professional resources help Chinese investors identify, analyze, evaluate, validate, acquire, finance and manage hotel and real estate opportunities. We have closed more than $1.5 billion of EB-5 financing for our developer clients and sourced more than half of that.