The steady growth of the hospitality sector in Germany means many new hotels are on the way to meet demand in the months and years to come. At the same time, hotel owners will need to reposition countless hotels opened in the 1990s as a result of favorable tax incentives, which have expiring operating contracts.

Thus, hotel operating agreements need to be renegotiated and executed, often with international hotel chains. Due to changes in international financial accounting standards, only a few of these operating contracts will be executed as lease agreements; a significant number will be hotel management agreements.

The separation of hotel operator and owner functions is typical in the international hospitality industry (“bricks and brains”). A hotel management agreement must bring together the interests of both, its often standardized contents originating from US hotel industry practice. This is a highly specialized type of contract: The hotel operator takes responsibility for the management and operation of the hotel, however, in the name and on behalf of the hotel owner. All the while, hotel assets, including staff, remain with the owner. At the same time, the operator is making available its valuable international brand as well as contributing vital know-how, staff training, marketing tasks and integrating the hotel into its international distribution network. The operator may, at its own risk, have developed the hotel project before. It will be interested in securing a long-term presence for its brand as well as preventing brand dilution by ensuring the highest possible standards while often employing a global customer loyalty program.

Meanwhile, the hotel owner seeks to cover at least the principal and interest of its bank financing with revenue, regardless of general economic fluctuations over the years. The owner’s bank wants to see steady operations over the course of the financing period, which is why it is not uncommon to have a fixed 20-year term with extension options for the hotel operator. The hotel operator enjoys extensive control over the hotel, including the ability to carry out significant renovations and improvements at the owner’s costs to keep the hotel up to brand standards. Compensation for such hotel management and brand licensing is typically made in a fixed base amount, combined with a performance-based incentive fee. Special compensation is often arranged for particular business activities, such as marketing, staff training and distribution network integration. The operator guarantees performance only in individual cases, for which there are a number of possible contractual solutions.

Legal conflicts are foreseeable when one party falls short of the other’s expectations during the fixed contract term. In these cases, predefined international contractual standards quickly meet the shallow waters of German contract law. It is often not realized in practice that a long-term management agreement should enable the hotel owners to cover at least the principal and interest payments of its financing. The German Federal Supreme Court determined this could be grounds for extraordinary termination of the agreement due to unconscionability, making it essential that a hotel operator and brand provider should carefully check the final agreement for a reasonable prognosis in this regard. When in doubt, a corresponding limited performance guarantee is often a good idea.

Another unforeseen stumbling block is that an international hotel management agreement, in the eyes of German company law, is classified as a so-called business assignment agreement (Betriebsüberlassungsvertrag) which is a type of a formal intercompany agreement according to section 293 para 1 no. 3 of the German Stock Corporation Act (Aktiengesetz). Should the owner be a German stock corporation or limited liability company, a notarized shareholder resolution has to approve the final agreement which must also be entered in the German commercial registry if the company’s assets are mainly the hotel assets. Failure to do so would allow each side to notify this defect, thus ending all contractual obligations. This is tantamount to an extraordinary contract termination. A similar situation applies if the owner is a limited partnership. Large hotel chains are often reluctant with official registrations, fearing the publication of individual negotiation results of the agreement. In this case, this would require most sophisticated legal artwork. As a possible solution, the entire agreement might be split up into separate contracts with separate risk allocations so as to avoid the typical elements of a business assignment agreement.

As a further hurdle, certain regulations of the German Civil Code on general terms and conditions need to be observed to avoid partial invalidity of the agreement. Though uncommon in international practice, such regulations apply to some extent as between companies.

All in all, rather brains than bricks are required when structuring and negotiating a hotel management agreement in Germany.

Dr Ulrich Schroeder