No One Puts Hoteliers in the Corner

By: Nirav Patel

As the Franchisee and Franchisor relationship is characterized by cooperation and substantial investment, with continued royalty payments, there are numerous issues involved for the franchisees in ensuring their investments are secure and profitable. The hotel industry within the United States is the most common illustration of this dynamic. The lodging industry generated $176 billion dollars in revenue with nearly 5 million guestrooms within United States in 2014.¹ Franchising is extremely important to hoteliers as the brand value and competitive advantage derived from franchisor support and proprietary systems/information allows for differentiation beyond their independent competitors. Nevertheless, the franchise agreements utilized to structure and secure this relationship is often costly. Within the hotel industry, La Quinta Inn & Suites, Hampton Inn, and Hilton Garden Inn retain the highest costs to revenue ratios, providing these franchisors the opportunity to capture upwards of 14% of room revenue from franchisees.² Thus, placing greater emphasis on due deliberation and negotiation in structuring and forming the Franchise Agreement.

Numerous factors are considered when contemplating franchise terms and conditions; including but not limited to, franchisee success and experience, new construction vs. existing operations, and projected profitability. When analyzing and deliberating the terms of the franchise agreements, however, the following are most commonly negotiable in favor of franchisees:

1. Royalty Fees, Systems Fees, and Franchise Payments – Franchisors are positioned to negotiate and reduce ongoing fees for franchisees when seeking to establish or continue franchise relationships with proven franchisees.³ These reductions may also be granted based on perceived value of the market and specific commercial property. However, with increasing fee structures, Franchisors generally offer only temporary reductions as these fees represent perpetual revenue streams; and they are more likely to decrease initial fees.⁴
2. Territorial Protection and Exclusivity – It is essential for hoteliers to consider their positions within the market. As initial entrants, the competitive advantage derived from being first to market are enormous. However, despite its benefits, these hoteliers are limited in their analysis of the market potential. The proformas, or projected operations of these businesses, is skewed due to lack of competitor analysis and consideration. When other hotels arrive within the market, the existing monopoly structure fails and revenue is substantially reduced. Thus, territorial protections, regardless of their temporal limitations, are essential.⁵
3. Independent Management vs. Approved Management – Franchisees often assume independent operation and management of their hotel, relying on their entrepreneurial abilities to successfully address issues of capital expenditures, implementation and satisfaction of brand standards, property improvement plans (PIP), and vendor selection. However, Franchisors are increasingly requiring the use of proven management companies to protect their investments and brand image. Although proven and more successful franchisees are capable of combating and countering such requirements, newer franchisees should seek to prevent franchisor ability in selecting management of the hotel.
4. Liquidated Damages – These damages allow franchisors to ensure loyalty by providing for recovery in the event of early termination of the franchise agreement. During franchise negotiations, franchisees are capable of reducing franchise fees and events triggering payment of liquidated damages.⁶
5. Property Improvement Plan – The PIP requirements for hoteliers can often turn a profitable investment into a costly mistake. Franchisors implement ongoing and renewed brand requirements to ensure minimum standards and congruency amongst existing properties. Although Franchisors retain substantial power in enforcing and terminating franchise agreements based on non-compliance,⁷ franchisees are capable of negotiating extensions for such requirements and of arguing for waivers.

Other key topics for hotel franchise negotiations are Ownership Transfer, Capital Investments, Personal Guarantees, Post-Termination Trademark Infringement, and Key Money.⁸ However, the ability and opportunity to argue these elements is often derived from the franchisee’s business savvy and legal representation. These terms are clouded amongst boilerplate clauses, that neither the Franchisor nor the Franchisee understand. Thus, it is crucial to seek legal guidance for review of franchise agreements and ensure security and success for your investment.

[1] https://www.franchisehelp.com/industry-reports/hotel-travel-industry-analysis-2018-cost-trends/
[2] https://www.statista.com/statistics/364544/hotel-brands-with-the-highest-franchise-costs-to-room-revenue-us/
[3] http://www.nwhotelinvestor.com/negotiating-a-hotel-franchise-agreement/
[4] https://www.franchisehelp.com/franchisee-resource-center/what-to-negotiate-in-the-franchise-agreement/
[5] https://www.franchisehelp.com/franchisee-resource-center/what-to-negotiate-in-the-franchise-agreement/
[6] https://hotellaw.jmbm.com/hotel_franchise_agreements_8_things.html
[7] Pooniwala et al v. Wyndham Worldwide, Inc. et al, No. 0:2014cv00778 - Document 36 (D. Minn. 2014)
[8] https://www.goldlawgroup.com/national-franchise-litigation-attorney/; see also https://hotellaw.jmbm.com/hotel_franchise_agreements_8_things.html.