It is common practice and often considered a “best practice” to begin the process of defining the owner-and-operator relationship under which a hotel operator/manager will be responsible for hotel management pursuant to a hotel-management agreement by first negotiating and executing a letter of intent. Why is this so important? The LOI describes the elements of the HMA that are considered crucial by owner and manager and is an excellent device for the complete illumination of crucial deal points in advance of negotiating the definitive agreements.
If the hotel is a highly desirable project, owner and owner’s team of consultants and lawyers can use the form of LOI offered by competing manager suitors during an RFP process to compare, contrast and distinguish one potential manager from another as part of the selection process.
Some, including this author, suggest that the LOI be thorough and complete even though it may take longer to negotiate. The LOI will address the mundane basics such as a description of the hotel, including the number of guest rooms and suites, as well as a description of any meeting space, food and beverage outlets and other amenities such as a spa and fitness center.
It is common for the first draft of the LOI to be generated by manager, from the business discussions between the parties, so owners should be mindful that the initial LOI received from a manager will be manager’s tried-and-true form and is likely to contain everything that manager wants in the agreements.
This makes it particularly crucial that owner not only carefully review the LOI, but also undertake the more important task of finding deal elements that are not in the manager’s LOI. Looking for something that is not there is far more challenging than reading what is there, and, most importantly, requires owner to know what might be in the LOI if owner knew to ask for it. This is where the negotiation becomes interesting for owners.
But why do that now at such an early stage? Why not get the owner and manager bound to the LOI so they can negotiate exclusively with each other and no one else for the time stated in the LOI? Many assert that if there is not going to be a meeting of the minds between owner and manager on things that are important to owner or that may be required by owner’s investors, it is best to get those issues resolved at the LOI phase.
What if you don’t? If the negotiation of the agreements has only a general LOI in place, it becomes difficult for owners to insert other important terms into the agreements later. The manager is likely to argue that if owner had essential deal points, they should have been in the LOI and that if owner asserts them now, it is “re-trading” with manager.
In addition, the proper and professional negotiation of the agreements is an expensive exercise. Each side will have activated a team of ancillary professionals to engage in the process and it is both unfortunate and expensive for an owner or manager to terminate negotiation of the agreements over deal points that could have been fully negotiated and resolved in the LOI.
Negotiating Letters of Intent
So what might be so important to negotiate upfront in the LOI? For now, here are just a few topics among the many that an owner might consider important. Every deal is different, and owners may want a variety of things dependent on who or what they are, such as a private REIT, family office or sovereign wealth fund. The term of the agreement seems simple on its face.
But what about extensions of the term? Does manager have the ability to unilaterally extend the term? How many times? For how long? Any specific requests should be in the LOI. What about sale of the hotel? Does the initial LOI include the owner’s right to terminate the HMA upon sale of the hotel to an unaffiliated third party? When, how, and with what fee paid for early termination? Is there an area of geographic exclusivity to preclude manager from managing a competing hotel close to owner’s hotel? For how long? How close is too close for owner’s particular hotel?
These are a few basic examples to bring us back to the main theme of the lesson. The LOI is not a document intended solely to get owner and manager to commit to each other. It should be as long and as detailed as it needs to be to cover every “deal breaker” issue for owner and manager. This will help make the LOI the blueprint of the deal and streamline the negotiation of the agreements.
The Global Consultant, an ISHC column examining the trends, challenges and opportunities shaping hospitality, is a Hotel Management contributed column by ISHC members monthly.
Nelson Migdal is global hospitality group co-chair, Greenberg Traurig.
