We frequently are instructed to review management and franchise contracts for potential owners looking to bring in a TPO or franchise a big brand. Buried in amongst the legal clauses towards the back of the contract are the clauses dealing with liability and insurance, which are often overlooked in the excitement of discussing performance tests, fees and completion deadlines. However, they merit careful consideration on a commercial level as, if they are not dealt with correctly, they could be a millstone for the owner for the duration of the hotel contract.
In a franchise contract, the brand will take no risk in the operation of the hotel; it supplies the brand and the system under which the hotel will operate, but all the risk (and hopefully reward) is retained by the owner. To back this up, the brands will usually insist on an indemnity in the franchise contract so that the owner is liable for any claims which are made by third parties against the brand arising from the operation of the hotel – regardless of whether the owner has done anything wrong or not. This is frequently backed up by an obligation on the owner to insure against those risks, to the satisfaction of the brand.
The situation is similar with management contracts, where the operator wants to avoid taking any risks, and will usually require the owner to indemnify it as well, although operators will usually accept that they cannot be indemnified where the operator has done something badly wrong in the performance of its duties. Again, frequently, the indemnities required by the operators need to be backed up by insurance.
The arrangements for the provisions of insurance as between owners and operators vary quite a lot. The traditional model was that owners would be responsible for getting their own property and contents insurance policies, and operators would be responsible for arranging for operational insurance to cover issues such as business interruption, public liability and employee liability etc. This has shifted somewhat over the last few years, and now operators quite often require owners to obtain all insurance covering the building and business of the hotel. The latest (eleventh) edition of the Uniform System of Accounts puts both operational and property insurance as an owner expense, which is excluded from the scope of Operational Expenses for the purpose of calculating Gross Operating Profit. The result is that the cost of insurance is not deducted for the purpose of calculating GOP-based incentive fees.
This also means that an owner cannot rely on the operator getting the right insurance policy to cover the indemnities that have been given under the management and franchise contracts; the owner often must do so itself. Although operators, and quite often franchisors, will have policies which they can recommend as meeting their requirements, the onus is still on the owner to make sure that the policies match its contractual obligations, and will not leave the owner with uninsured risks that would need to be paid out of its own pocket.
Another issue that we have seen surfacing in recent years is how claims are dealt with. Many franchise agreements will include in the indemnity a term that allows a franchisor to handle an indemnified claim (particularly one which may have an impact on brand reputation) itself, rather than leaving it to the owner (or its insurers) to resolve, but still keep the owner on the hook to indemnify the franchisor against the liabilities and expenses of the claim. However, virtually any hotel insurance policy will provide that any claim covered by the insurance must be controlled by insurers (or at least subject to their approval). This can leave owners facing a situation where, because the brand is insisting on controlling the claim, the insurers will not cover it, meaning that the owners have to reimburse the brand under the indemnity in respect of the claim out of their own pocket.
The key to getting these issues sorted out is to deal with them upfront in initial discussions with both operators and brands to make sure that you understand their approach to these types of risk, and where appropriate insist on amendments to standard positions to make sure that the owner’s liability will always be covered by insurance.