Whether you are considering developing a hotel or acquiring a hotel, in order to maximize your revenue per available room (and obtain capital investors and financing), you are likely to turn to one of the major hotel brands to "flag" your hotel with an appropriate hotel brand. The document that formalizes your rights and obligations is known as the hotel "license agreement" or "franchise agreement." For many owners, their understanding of this important agreement does not extend beyond the basic economic terms of royalty fees, "areas of protection," length of term, and possibly "key money."
This article will demystify this critical document by: (1) generally describing what franchise agreements are; (2) summarizing some of the most material terms within the hotel franchise agreements; and (3) suggesting which terms may be open to negotiation with the franchisor/hotel brand.
The franchise agreement is a license agreement between the hotel owner and the hotel brand that sets forth the rights and obligations of the owner to operate the hotel under the brand or "flag" in exchange for fees. Franchise agreements are essentially licenses, which means that they are personal and cannot be assigned by the current owner. These agreements are drafted by the hotel brand companies and are very one-sided.
Even though franchise agreements are drafted in favor of the brands, most owners are more than happy to sign them since the right flag (and its reservation system) is enormously beneficial to the owner’s business. The right flag can significantly increase hotel occupancy and the room rate and add upwards of 20%-40% to the value of a hotel when compared to "unflagged" or weaker brand options.
As you would expect, franchise agreements contain hundreds of material terms. However, some of the more important terms address:
Very few of the "legal" terms in the franchise agreement are open to negotiation, but if raised while negotiating the term sheet before "committee approval" by the brand, there are several "business terms" that owners have some ability to negotiate. Owners will have more negotiating leverage on the economic terms if they are developing the hotel instead of buying a stabilized asset. The terms that are considered business terms and are potentially subject to negotiation are:
An owner’s ability to obtain concessions from the brand is largely dependent on (1) the owner’s leverage (i.e., is the owner developing a new hotel or agreeing to perform a major renovation; does the owner own several other hotels within the brand family); and (2) the owner’s knowledge of the issues. If an owner does not have deep experience in franchise agreement negotiations, the owner should hire an experienced hospitality attorney and/or hotel consultant to guide the owner through the negotiations.
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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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