Key money in Hotel Management Agreements: market practice, legal aspects and accounting issues

Key money is a common practice in the hospitality sector, particularly in connection with hotel management agreements (HMAs). Key money is often negotiated alongside the term sheet, and can raise a number of complex legal, accounting and tax issues. In this article, we look at current market practice, the legal implications of key money and the main points to consider when negotiating it between owners and international operators.

1. Market practice

1.1. Negotiation, and inclusion in the hotel management agreement

Key money is generally negotiated at the same time as the term sheet and HMA. The operator’s commitment is usually set out either in the term sheet or in a separate letter, as a unilateral undertaking in favour of the owner.

Features of a key money agreement

• Key money is normally paid by the end of the month following the hotel’s opening.

• The key money agreement generally includes a number of conditions for the hotel owner, such as:

  • Signing the HMA under the operator’s brand for the period set out in the term sheet.

  • Signing the Technical Assistance Agreement.

  • Carrying out any required renovation or refurbishment work and bearing the related costs in order to comply with the operator’s brand standards.

  • Obtaining the necessary authorisations to open the hotel to the public.

The operator issues the owner with an invoice on the same day the key money is transferred.

1.2. Repayment terms and guarantees

If the management agreement is terminated early, the term sheet or letter will specify the conditions for repaying the unamortised portion of the key money. The straight-line amortisation method is often used, calculated over the term of the HMA.

Guarantees 

• The operator may require the owner to provide either a corporate guarantee from its holding company or a bank guarantee to secure repayment.

• The guarantee generally becomes effective on the day the hotel opens, when the money is transferred.

Industry practice

• International operators typically offer guarantees.

• Accor and, on occasion, Hyatt (subject to conditions) do not adhere to this practice.

In practice, operators assess whether the owning entity has a substantial hotel portfolio and sufficient financial strength to support the guarantee.

2. Legal aspects and accounting treatment of key money

2.1. Definition and purpose

Key money is essentially a financial contribution made by the operator to the hotel owner following construction or renovation. It may be used for several purposes, including:

• Financing an investment in fixed assets.

• Supporting the hotel’s operations, particularly during the opening period.

• Acting as an incentive to secure a new hotel management agreement.

The key money agreement, initially drafted by the operator (and then lightly amended by the owner), will set out its purpose.

2.2. Accounting treatment on the owner’s side

• In France, key money is generally treated as a subsidy and is recorded as such in the owner’s accounts.

• It is considered a form of financial support and may be subject to immediate taxation through recognition in the profit and loss account.

• Key money is not included as part of goodwill, as this type of subsidy is not part of the hotel’s assets.

• In France, public grants from the central or local government must follow accounting amortisation rules.

Tax and VAT

• If the subsidy enables the hotel to begin trading, it is considered to be linked to the business and may be treated as revenue subject to VAT.

• Where there is any doubt, it is generally safer to apply VAT as a precaution, since VAT is recoverable in France.

2.3. Accounting treatment on the operator’s side

• From the operator’s perspective, key money is recorded as an expense.

• The agreement must therefore be sufficiently detailed to show that the payment qualifies as a deductible expense for the operator.

3. Key issues and practical recommendations when negotiating key money

Considering the financial, accounting and tax implications, the parties should take particular care when drafting the key money agreement and guarantee, ensuring that they clearly set out:

• The context and purpose of the key money.

• The repayment terms in the event of early termination of the HMA and/or the sale of the hotel during the term of the agreement.

The transaction should be properly documented through:

• The key money agreement and the key money guarantee.

• The invoice issued by the operator.

• The minutes of the management body meeting, validated by the usual legal advisers, tax advisers and auditors.

Best of luck with the negotiations!