The Practice Of Key Money In Hotel Management Agreements In France
By Christopher Boinet, Lawyer at the Paris Bar and Partner at In Extenso Avocats
In hotel management agreements, hotel chains and owners regularly negotiate what is referred to in the industry as key money. This is the case when competing hotel chains invited to tender by owners are prepared to invest significantly in the long-term management of high-end properties considered strategic for their development. Often considered as proof of a hotel operator's genuine interest in managing a specific property, key money can be a valuable resource enabling a hotel chain to expand on new markets and in strategic locations, without having to allocate significant costs to such development. The brand is thus able to invest in a selected hotel, transforming it into a flagship property.
Yet can key money - a form of financial contribution by the operator - create ambiguity surrounding the lawful nature of the owner-operator relationship? Indeed, it could be argued that this relationship, a priori contractual only, could in this way morph into an affiliation between associates, depending on the type of assistance or financial advance negotiated. It should be remembered that operators primarily want to manage hotels (as we hear so often from international brands) - indeed this is their core business. When negotiating, operators generally prefer to make concessions on their fees by granting exemptions or reductions rather than offer any form of loan or advance, key money in particular.
On the other hand, the operator's obligations with regard to key money, the minimum guarantee or the performance test can be perceived by owners as evidence of the operator's additional involvement and willingness to take a risk on the management of the property in question -factors which tend to reassure owners.
In negotiations, owners will question how committed operators are: what are they ready to accept and just how far will they go?
In practice this can be clearly seen: as with all clauses up for discussion in a hotel management agreement, key money is negotiated at the expense of or in return for something else - higher fees and/ or a longer contract term, for instance. There is, notably, almost always a trade-off between key money and the minimum guarantee that must be established before entering into negotiations with a hotel chain, and it is very rare for an owner to obtain both (in satisfactory proportions).
From the owner's point of view, key money and the minimum guarantee both meet the requirement to align interests. While key money can provide financing to secure an initial investment, it is usually less sought after in the case of an existing hotel with an established track record and that is seeking a new operator. Compared to the minimum guarantee, key money does not ensure the secure return that owners particularly require if they are institutional investors, or if their investment is backed by bank financing, for example.
Furthermore, the greater the amount of key money contributed by the operator, the higher their management fees (as a percentage of Total revenues or GOP, etc.) and/ or the longer the contract term, since the operator will seek to offset the initial cash injected (NPV calculation).
Owners must determine whether they would prefer a secure return with a minimum guarantee. Indeed, in the event the property is put up for sale, a secure return will constitute a strong point for negotiating with a prospective buyer who will regard such as a valuable guarantee for financing the acquisition. Consequently, it is necessary to understand the personal strategy of the initial owner, and in particular, to find out before negotiating with the operator, whether the owner intends withdrawing from the contract in the more or less short term.
On the owner's side, the impact of key money on the balance sheet/ amortisation (straight line) over the term of the contract must be taken into account, and the accounting nature of key money could be questioned: is it debt or quasi-equity?.... key money will be treated as a benefit that may be immediately taxable when recorded in the P&L as income.
Additionally, almost all operators require the owner to commit to reimbursing on a pro rata basis any outstanding key money due or an agreed proportion of such (with or without interest) if the agreement is terminated early.
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