HOTEL MANAGEMENT CONTRACTS: BREACH OF CONTRACT, TERMINATION, AND DAMAGES, PART 1

1999

Robert H. Wilson

Robert H. Wilson

ABSTRACT

Recent court decisions have redefined the relationships and expectations of both owners and operators involved in hotel management contracts. What were once considered irrevocable contracts that a court would enforce with an order for specific performance are now likely to be contracts that can be revoked (but which may carry the risk of damage awards). This paper looks at contract law and examines several interesting hospitality court cases to determine the types of damages that would be available in the event a court determines that a manage­ment contract has been breached.

Introduction

A hotel management contract is a detailed contract containing the rights and obliga­tions of the hotel owner and the rights and obligations of the operating management company hired to manage the hotel. All aspects of the operation and management of the hotel—including renewal terms, management fees, payment of expenses and operator expenses, renovations, operating budgets, financial reporting, operator’s duties, ter­mination rights, and length of contract—are some of the issues that are addressed in the typical hotel management contract (Eyster, 1988). In addition, many management agree­ments usually provide that the contract is irrevocable and cannot be terminated without cause. Generally, management contracts provide that either side is barred from terminat­ing the contract before its term is expired unless the other party somehow breaches or violates the terms of the agreement.

A series of court cases continues to define the power of owners to terminate existing hotel management contracts, notwithstanding clauses contained in the agreements pro­hibiting early termination. The cases are Wooley v. Embassy Suites (1991); Pacific Land­mark v. Marriott (1993); Government Guarantee Fund of Finland v. Hyatt Corporation (1995) and (1998); and 2660 Woodley Road Joint Venture, Woodley Road Associates, Inc., John Hancock Mutual Life Insurance Company, and Sumitomo Life Realty, Inc. v. ITT Sheraton Corporation and Sheraton Operating Corporation (1998). A quick reading of these cases may lead one to assume that a hotel owner may make an early termination of a management agreement and suffer no adverse consequences. I encourage the reader who is not familiar with these cases to review several interesting articles that have been written on the topic. Michael Shindler (1997), James Eyster (1997), and Robert Wilson (1999) are some examples of such studies.

While the law is evolving, the courts clearly point out that while an owner may have the power to terminate or revoke an existing hotel management agreement without cause, the owner runs the risk of breaching the contract. Major issues or questions that were not resolved by the cases (and which will be discussed in this article) are the types of remedies and types of damages that would be available if either the management com­pany or the owner terminates the agreement without cause prior to the end of the agree­ment.

Review of Case Law

The following cases focus on the rights and powers of owners to terminate existing management contracts by applying existing definitions and interpretations of the laws of agency.

Wooley v. Embassy Suites

In Wooley v. Embassy Suites, 227 Cal. App. 3d 1520, 278 Cal Rptr. 719 (1991), Robert Wooley and Charles Sweeney were partners who owned 22 hotels. Embassy franchised all the hotels and managed 17 of them under 17 separate management contracts. The management agreements provided for termination of the management contracts only in the event of a breach of contract by either party, after notice of termination, with a right to cure the breach by the operator, and with arbitration. Wooley attempted to terminate the contracts of 9 hotels by delivering notices of default, alleging that Embassy had “materi­ally breached the management contracts by making expenditures in excess of budget al­locations” (p. 1525). Embassy obtained a preliminary injunction in a lower court enjoin­ing Wooley from terminating the management contracts pending a resolution of arbitration to determine whether Embassy had breached the contracts. Wooley argued that he had the right to terminate because Embassy was an agent of Wooley, and that an agent’s continued employment can be revoked at any time.

While the court found that Wooley could terminate the management contract at any time, there was a warning about the consequences of the termination. The court stated that while the “principal has the power to revoke an agent’s authority at any time before the agent has completed performance” (p. 1529), the “agent’s remedy for wrongful ter­mination is damages, as in any other breach of contract law” (p. 1530). “The principal’s power (to terminate the contract) is absolute and applies even if doing so is a violation of the contract or the agency is characterized as ‘irrevocable'” (p. 1531, Rest. 2d Agency, sec 118, com. B., p. 300). The courts indicate in these cases that even though the party who terminates a management contract without cause has the power to terminate, a breach of contract may still result.

The court ruled that hotel management contracts are personal service contracts, and that the rule against specific performance applies. (Specific performance will be dis­cussed later in this article.) The Wooley case left unanswered one significant question: if an owner terminates a hotel management contract without cause, what are the damages that the hotel owner can be forced to pay for the wrongful termination? (Issues involving “agencies coupled with an interest” and the power to revoke will not be discussed in this article.)

Pacific Landmark v. Marriott

In Pacific Landmark v. Marriott (1993), the California court clarified some of the un­answered questions from the Wooley case. Pacific Landmark owned a hotel on land it leased from the San Diego Port District. Pacific entered into a series of contracts with Marriott International (at that time a wholly owned subsidiary of Marriott Corporation) and San Diego Hotels, Inc. (a wholly owned subsidiary of Marriott Corporation) in Octo­ber, 1987. Two of the contracts were management contracts allowing Marriott Interna­tional to become the manager of the two identical hotel towers standing side-by-side on the shore of the San Diego Bay.

On December 3,1992 (subsequent to the ruling in the Wooley case), the owners sued the defendant Marriott companies and sought damages for breach of the management agreements. On December 31, 1992, the Landmark gave notice to Marriott International of the breach of the agreement, along with its intention to terminate the management agreements on January 31,1993. Marriott International refused to leave the hotel, claim­ing that the contracts were irrevocable.

The court stated, using the Wooley v. Embassy Suites case as precedent, that “even if a hotel management contract did attempt to restrict the power of the owner to terminate the manager, such provision would be ineffective unless the agency were coupled with an interest, because the principal’s power of revocation is absolute and applies even if doing so is a violation of the contract or the agency is characterized as ‘irrevocable'” (p. 625). Again, as in the Wooley case, the court found a principal agency relationship ex­isted, that no agency coupled with an interest existed, and found that the owners had the power to revoke the management contract. The court also noted that when an owner ex­ercises the power to revoke an existing management contract, it may still be breaching the agreement and subjecting itself to damages for breach of contract.

No decision was rendered as to whether the revocation was a breach of contract, as the case was sent back to the lower court. The parties eventually settled the case without the court resolving the issue of breach of contract and damages owed.

Government Guarantee Fund of Finland v. Hyatt Corporation

In the case of Government Guarantee Fund of Finland v. Hyatt Corporation (1995) and (1998)—a case originally heard in the District Court of the Virgin Islands—the court again considered the question of the validity of a revocation of a hotel management con­tract that had been originally intended by the parties to be irrevocable. The Government Guarantee Fund of Finland became the owner of the property as part of a bank bailout of Skopbank (the original lender). The Government Guaranty Fund of Finland ultimately sold the property to 35 Acres Associates.

On March 21, 1995, and again on June 8, 1995 (the Wooley case was decided in 1991 and the Pacific Landmark case was decided in 1993), 35 Acres Associates wrote to Hyatt, stating: “GGF, Skopbank, and 35 Acres consider the Management Agreement between

Hyatt Corporation and Great Cruz Bay Development Company, Inc. as void, terminated, and/or expired.” On June 8, 1995, 35 Acres demanded that Hyatt “immediately surren­der possession of the Hotel ” to 35 Acres. The owner, 35 Acres Associates, filed suit and Hyatt filed a counterclaim. On appeal, the court said “the parties agree that this appeal focuses only on 35 Acres’ power to terminate the agency and its right to possession of the hotel and related property, as well as transition matters, irrespective of the ultimate result of the remaining litigation. Thus we do not consider whether 35 Acres wrongfully termi­nated Hyatt’s management rights” (p. 297). Hyatt argued that 35 Acres did not have the power to revoke the contract because the parties intended the contract to be irrevocable by creating an agency coupled with an interest.

In discussing the applicable law, the court, quoting the Restatement of Agency, states:

The principal has the power to revoke … although doing so is in violation of a con­tract between the parties and although the authority is expressed to be irrevocable. A statement in a contract that either party cannot terminate the authority is effec­tive only to create liability for its wrongful termination. The only exception to the rule that principals may terminate an agency relationship at any time is when the authority granted to the agent is a power given as a security” (p. 300).

The court said that whether agency contracts can be revoked or are irrevocable is a matter of law. Even if the parties intend to create an irrevocable agency, one coupled with an interest, they must, in fact, create the agency coupled with an interest. If they have not created a valid agency with an interest, the principal (owner) retains the power to revoke the agency. If the revocation is “contractually unjustified” (p. 307), the court may order that damages be paid.

2660 Woodley Road Joint Venture, Woodley Road Associates, Inc., John Hancock Mutual Life Insurance Company and Sumitomo Life Realty, Inc. v. il l Sheraton Cor­poration and Sheraton Operating Corporation

In this case, 2660 Woodley Road Joint Venture, hereafter called “Joint Venture,” owned a large convention hotel which it leased to Woodley Road Associates, Inc. (“Woodley Road”), a wholly owned subsidiary of John Hancock Mutual Life Insurance Company (“John Hancock”). The defendant, Sheraton Operating Corporation (“SOC”), is a wholly owned subsidiary of defendant ITT Sheraton Corporation (“ITT”). SOC man­aged the hotel for Woodley Road pursuant to a management contract that was signed in 1979. The management contract expired in the year 2000 but also contained rights to ex­tend for three ten-year periods. The joint venture agreement provided that both John Hancock and Sumitomo would agree on major decisions. John Hancock and Sumitomo agreed to terminate the management contract and the agency of SOC. SOC refused to leave the property and contested the right of John Hancock and Sumitomo to terminate the management contract. As part of their suit, the plaintiffs filed a motion for a prelimi­nary injunction asking the court that the defendant SOC be ordered out of the property before the court heard the rest of the case.

The court reiterated the reasoning that was used in the Wooley v. Embassy Suites, Pacific Landmark v. Marriott, and Government Guarantee Fund of Finland v. Hyatt Cor-poration cases. Both parties had stipulated that the issue is a question of agency law. The court found that “an agent’s authority terminates if the principal or the agent manifests to the other dissent to its continuance. This well-established rule permits the revocation or termination of agencies at any time by either party, even where doing so constitutes a breach of contract” (p. 4). “The only exception to this rule is when the authority granted to the agent is a ‘power given as a security'” (p. 5). The court followed the reasoning used in the other cases to establish that a power given as security did not exist, that the agency was revocable.

A careful reading of these four cases reveals the courts’ thinking and reasoning. They are reluctant to change one of the basic tenets of agency law: an agency relationship can be revoked by the principal (hotel owner), thereby terminating an existing management contract. However, this revocation may be a breach of the contract and may subject the hotel owner to a damage claim for wrongful termination or breach of contract. The courts are more willing to allow a revocation of the contract and to order damages to be paid to the management company than they are to force the performance of personal services contracts. The courts will allow a management contract to be irrevocable under certain limited conditions when the courts determine that an agency coupled with an interest exists.

The cases are all clear on one point: most hotel management contracts create a princi­pal/agent relationship where the hotel owner is the principal and the hotel operator is the agent of the owner. The laws of agency define, modify, and regulate the rights and obligations that the parties have agreed upon in the management agreement. Many hotel management contracts may be terminated without cause by either the owner or the oper­ator, and contract law will be used to determine remedies and damages if the termination is wrongful. While many courts have rendered decisions providing for damage awards for breach of contracts, much of the uncertainty in the hospitality industry exists because the courts have not yet determined what remedies are available in the event of an early termination without cause of a hotel management agreement.

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