Originally published in Business Ukraine, September 2008
The hotel business is widely regarded as one of the less developed spheres of the Ukrainian hospitality industry, but this situation looks set to change over the next four to five years. These changes will come not only as a result of the forthcoming Euro 2012 championships but as a direct response to the rising demand generated by a growing business travel and tourism sector. Ukraine is going through a period of rapid expansion of its international commercial relations and as a result not only Kyiv but almost all the country's administrative centres are facing the welcome challenge of meeting what are continually increasing levels of demand. Cities including Donetsk, Lviv, Dnipropetrovsk, Zaporozhe and Odesa have joined the country's under-developed resort areas in the fight to bridge the gap created by a lack of the high-quality hotels which the new generation of middle-class business people and tourists is looking for.
Massive Market Finally Matures
A number of well-publicised factors continue to hinder the development of a world-class hotel sector in Ukraine. Lengthy procedures relating to land plots and the long list of government stamps needed before work can begin remain major stumbling blocks, while problems over the way in which the state regulates the sector and a chronic lack of modern infrastructure also contribute to the underdeveloped state of the market. However in spite of these shortcomings, several years ago the major Ukrainian financial and industrial groups began turning their interest to the hotel business. The most famous results of this direction have been a number of flagship hotels including the Opera in Kyiv and the Donbas Palace in Donetsk (SCM Group) and the IUD Corporation-owned hotels, the five-star Hyatt Regency Kiev and the three-star Yalta Intourist in Crimea. Following their successful development in Russia, such leading international hotel management companies and brand operators as the Rezidor Hotel Group, Wyndham Hotels and Resorts, Accor Group, Starwood Hotels & Resorts Worldwide, Fairmont Raffles Hotels, the Intercontinental Hotel Group and some others are now actively exploring the Ukrainian market.
Managing Operations, Minimising Risk
The legal mechanism of market entry for the major international operators now converging on Ukraine is based on hotel management agreements rather than outright ownership. In view of the instability of investment and the political climate in Ukraine, international operators rely on management contracts as a vehicle within which they may operate profitably without capital investment and with minimised perceived risks. Management contracts are the preferred business tool for international operators for a number of other reasons as well.
Ukrainian owners and developers are generally unfamiliar with such agreements. For them it is important to understand that hotel management companies initially have a quite strong position in negotiating the terms of hotel management. The international operator has experienced legal and financial negotiation teams, fixed policy standards and management expertise in different regions within different legal backgrounds. In addition, the operator has the name and reputation which the developers need, as well as the possibility to promote a new hotel worldwide through their existing networks. Owners starting negotiations generally focus on the level of control and powers of the operator, as the owners usually consider the operator's powers initially too strong, while the criteria for performance are unclear and termination provisions often appear insufficient. Owners are often unhappy with operator demands for contract terms that last too long and fees and costs that are delineated in USD or EUR.
Striking a Hard Margin for Long-Term Satisfaction
Further problems sometimes stem from the fact that few potential owners are ready to create a strong negotiating team with experienced negotiators and lawyers and to use the advantages, if any, of their land plot in the market. In many cases the owners are not acquainted in depth with the hotel business. However, this state of affairs in rapidly improving and now more owners and developers realise that the quality of the management agreement they reach directly influences the future saleability of the hotel and are prepared to discuss the latter professionally.
Many of the general global trends in hotel management will only reach Ukraine in few years, but it is safe to say that contracts worldwide will continue to have lower base fees and higher incentive fees. However, it is important to remember that contracts should be viewed and planned with a long-term perspective, which means that significant profit is unlikely to be achieved within the first 5-7 years of the contract.
Right Team Crucial for Successful Negotiations
Needless to say, a hotel management agreement should be a balanced one which is fair for both parties. Brand operators carry out negotiations for a living, so they enjoy the natural advantage of extensive experience, complete with qualified in-house or outside counsel to guide them in different jurisdictions. The more experience the owner's team of negotiators possesses, the better the chance the prospective owner will have of securing a favourable deal. Obviously, owners need to balance their representation to at least match that of the operators'. Usually the outcome of negotiations results from the interplay of the bargaining powers of the operator and the owner as well as from trade-offs accepted by each party. It is usually reasonable to accept a fallback outcome in one provision in order to gain a desired outcome in another (e.g. a lower basic fee vs. longer contract term). Certainly it is understandable that such factors as brand, market share, property location, status of competition within the market and even personality of the CEOs could influence the balance of negotiations.
Potentially Stumbling Blocks for Prospective Owners
Key issues within the broader negotiations are termination provisions (by operator and by the hotel, termination without cause, termination on sale of the hotel, etc); dispute resolution clauses (arbitration vs. litigation); performance test clauses; indemnification; confidentiality and non-competition clauses. The right to termination should be addressed in the hotel management contract to a variable extent. For instance, shall we consider termination without cause? What could be the grounds and procedures for such a step? For the prospective owner it is difficult to terminate a hotel management contract (especially if it does not provide for specific non-performance provisions) just by claiming that the operator does not act efficiently. In order to minimise the risk of becoming bogged down in long-lasting arbitration or litigation the owner could negotiate for specific provisions in the contract allowing him to terminate if the operator does not reach objective performance criteria. Such termination without cause allows an owner to terminate the hotel management contract without the need to give reasons for doing so. However, termination without cause could be followed by certain payments to the owner, depending, e.g. on the year of termination.
Another important issue is termination on sale of the hotel. This right is an important one for potential owners who have a short-term exit strategy. The hotel management contract usually has a personal character to the owner, especially when it is connected with hotel business development in general and the establishment of the hotel brand in a new jurisdiction. As a result in most cases of hotel sale the operator's approval is required.
However, the owner could face significant resistance to early termination on sale and should be prepared to pay liquidated damages to exercise his right. There could be plenty of different sale situations connected with the peculiarities of the project which should be discussed from the commercial point first and them implemented through legal mechanism.
Keeping In-House Competition at a Minimum
Another thorny question is the issue of the operator's right to manage another brand hotel within the specified geographic area of the owner's property for a certain period of time. This generally requires clear and legally approved drafting. It can be difficult in practice for owners to ensure that their hotel is the only beneficiary of the brand in a particular market and thus careful consideration should be given to negotiation of territorial exclusivity and duration of any non-compete clause. As a general rule international operators traditionally resist such clauses.
Among important rights of the operator is the right to indemnification except for gross negligence or wilful misconduct. This right actually constitutes the main protection from the liabilities associated with the property for the operator. However, local laws should be taken into account in order to avoid inoperative provisions with regard to the scope of indemnified persons and payments.
It is also important to decide on applicable law and forum to be confident of your position even if a dispute arises. For an international contract in Ukraine the choice of foreign law as the law of the contract is not a problem. However, the influence of mandatory provisions of Ukrainian law on a specific issue should be tested. International arbitration is the best solution as a dispute settlement mechanism. Ukraine is a party to New York Convention of 1958 on recognition and enforcement of foreign arbitral awards, which adds confidence in enforceability of any international arbitral award rendered.
The majority of operators looking at Ukraine tend to propose their standard hotel management agreement. Legal counsels usually become more active in the negotiation process when the owner and operator have reached consensus on key issues of their hotel management agreement. It is usually preferable that the owner's counsel should introduce the legal language for all agreed amendments.
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