The complex practice of an arrangement between a hotel owner and hotel operating company, a well-accepted practice in the hospitality industry, starts with a memorandum of understanding (MOU), more simply known as a letter of intent. According to the Cambridge Dictionary, an MOU records the not yet legally approved agreement between two companies or organizations. In the hospitality industry, this was originally developed to allow hotel operators to expand their portfolios without the risk associated with real estate ownership through hotel owners, who take on the risk but have the expertise of the operator.
Approximately 21 percent of all hotels in Europe and 13 percent of all hotels in North America are operated under management agreements, as of 2015. Each is agreement unique, but once it is set, re-negotiation becomes increasingly difficult, making it necessary for all participants to understand the rationale behind common terms and issues that arise in the negotiation process the first time around. Doing so ensures a balance between the interests and goals of both parties.
The Horwath HTL Health & Wellness Industry Report, titled MOUs Explained, details what both owners and operators should know before stepping into the negotiation to foster cooperation and help achieve win-win outcomes, according to Ingo Schweder, chief executive officer of GOCO Hospitality and one of the report’s authors.
Similar to generic hotel management agreements, wellness resort management agreements last an average of 20 years and employ the same business model in which the operator receives a percentage of the gross operating revenue (GOR) and the gross operating profit for managing the property’s day-to-day operations.
The GOR, which is the foundation of the base management fee calculation, includes all direct or indirect income of the operation, such as rooms revenue, branded real estate rental program revenue, food and beverage revenue, service charges, laundry charges, telecommunications revenue, spa, wellness, and fitness facility revenue, banquet and catering revenue, parking revenue, and commissions on foreign exchange conversions.
The difference between the generic and wellness management agreements lies with the fact that the base management fees of wellness operators are higher than the industry average of 2.5-3.5 percent. Often, these fees average 4-8 percent of gross operating revenue for wellness resorts due to their smaller room inventory (which is usually between 50 and 100 keys). Additionally, the higher initiatives stem from wellness resorts requiring a greater level of technical know-how and practical experience from their wellness operators. This ensures appropriate design, clear strategy, pre-opening setup, and success of the overall wellness development.
Medical wellness resorts also require highly specialized expertise that neither holistic wellness operators nor hotel operators typically possess. Therefore, medical services such as dentistry, plastic surgery, and stem cell therapy are often outsourced to a third-party medical provider who is experienced in healthcare and hospital management. Given this, the wellness operator would manage the rooms, food and beverage outlets, and wellness components while the medical operator would oversee the medical center. In the MOU, it is essential to clearly state the allocation of the medial service revenue.
Wellness resort management agreements also differ as the owner may decide to sell any residential real estate that forms a part of the wellness resort. It is then common for the operator to charge an additional branding fee of approximately 5 percent onto the total sales price.
Spa consulting must also be looked at separately as it is often provided by small private companies experienced in spa-operations but lacking the in-depth knowledge of all-encompassing health and wellness developments. Spa operations are only one pillar of the wellness resort experience. Therefore, spa operations are typically less complex, so hotel and resort spas tend to focus more on product sales rather than spa performance.
Understanding the Most Common Terms Used in MOUs
“Operating terms,” one of the main commercial terms noted in the MOU, define the duration a hotel management agreement is to remain in effect. This typically lasts from the opening date or the agreement’s date of execution to the expiration of a specified number of years, ranging between 10 and 30 years. Normally, a more luxurious property would have a longer operating term than a more economy property.
It is important for an operator to have this term long enough for the hotel to establish itself and reap the benefits generated throughout the operator’s brand, as well as to rationalize the investment of time, effort, and experience put into the property. Because of this, operators typically prefer the renewal terms to be set in their favor and resist early termination rights of the owner.
On the other hand, hotel owners are advised to negotiate for a shorter term, an option for either party to not renew or terminate the agreement, a guarantee or performance where the operator is held to make up shortfall, and the ability to terminate upon sale of the hotel or if the performance is not met.
Additionally, the MOU states the operator’s brand name and proposed name for the hotel. It is the job of the owner to ensure they are each right for the intended market.
The operator will require the hotel is built and operated in compliance of the brand standards, policies, and specifications, making the owner responsible for complying with such standards, adequately staffing the hotel and maintaining the property at their own expense. Given this, it is important that the owner includes provisions in the MOU that keep maintenance and staffing within reasonable limits and within a predetermined percentage of the current fiscal year’s approved annual plan or budget. Similar terms apply for hotel rates, staff salaries, and staffing numbers as it directly impacts the hotel’s profitability.
The MOU will also briefly spell out the group charges, system fees, marketing contribution, and reservation fees desired by the operator. Usually, revisions or deductions will not be accepted, but the MOU should specify that all fees and charges are system wide and should be allocated amongst all operator-branded hotels on a fair and equitable basis.
All hotel personnel are employees of the owner, reporting to the general manager who will report directly to the operator. As the success of the hotel will largely depend on the general manager, the operator has the right to directly hire them, as well as other members of the executive staff. As a key liaison between the operator and the owner, the owner has an interest their selection, so the MOU should grant the owner the right to review and reject such candidates up to two or three times. The MOU should note that the salary of any such positions prior to the hotel opening should be agreed on between the two parties. While termination of such positions is the operator’s decision, it should be done after consultation with the owner. Likewise, the owner should have the right to raise this possibility for any legitimate reason.
What Happens if the Operator and Owner Do Not Agree?
With such different interests, it is common for owners and operators to not always agree. If not resolved, these disputes may lead to a contract termination. To avoid this, there are three main ways to settle a dispute between an owner and operator.
The first and easiest step in dispute resolution is an informal compromise, documented in an MOU, which eliminates the need for a formal contract amendment. If a disagreement cannot be handled in this way, an owner-operator committee must be formed made up of three representatives from each side. In a quasi-mediation form, the group tries to find common ground for an agreement and is documented by formal minutes. Lastly, if the conflict is not resolved by these two steps, the parties may move to a formal mediation or arbitration. The asset manager drafts a position statement, prepares for the process, and executes the solution.
The full report is available online. It's important to note that hotel owners are advised to seek professional legal advice when considering legal implications and location if dispute resolution of both the MOU and HMA.