Part One in a Three-Part Series

 PUNITIVE DAMAGES AFFILIATED WITH

HOTEL MANAGEMENT AGREEMENTS

 A Case Study of Agency Law, Hotel Management Agreements,

and Punitive Damage Awards

Citing the Cases of

Woolley v. Embassy Suites

March 2008

By Meg McDonough

President, Luxury Hospitality Consultants, LLC

In February 2008 Jim Butler, Hotel Lawyer and Author of www.HotelLawBlog.com, examined the legal intricacies in a breach of contract lawsuit involving the Ritz-Carlton Bali Hotel and the Four Seasons Resort on Bali. It’s an interesting case and one which illustrates the impact of hotel management agreements, contractual obligations, and the fiduciary duties of hotel management companies.

As part of my certification in Hotel Management (University of South Florida – Sarasota), I wrote the following case study on hospitality law as it affected not only the above-noted parties but also others with somewhat similar outcomes vis-à-vis punitive damages. The final outcome fell on how the courts interpreted management agreements as agency agreements and applying applicable agency law. First of all, is the discussion of the court’s interpretation of management agreements – or contracts as “agency agreements” involving a fiduciary duty owed to the hotel owner.

The most recent case involving this interpretation was P.T. Karang Mas Sejahtera v. Marriott International Inc., et al. (the “Owner”) (Farmer). This case involved a dispute between the owner of the Ritz-Carlton Hotel in Bali, Indonesia, and the hotel’s management company – Marriott International Inc. (“Marriott”).

[Citations to Jim Butler, author of www.HotelLawBlog.com.]

The second part of this series deals with the awarding of damages (compensatory and punitive) and the conditions which lead to damage awards.

The following elements depicting the role and structure of management companies help illustrate the need for competency, business savvy, and integrity in the management of hotel properties (Hayes, Ninemeier):

• “The financial success of any lodging facility is dependent… upon the quality and skill of its on-site management.”
• “In the 1950s and later, hotel owner groups began to purchase ever larger numbers of hotels. Their inability to actively recruit, train, and supervise the many general managers they required to manage their properties resulted in the growth of companies formed simply to manage hotels under ordinary as well as out-of-the ordinary circumstances.”
• “Today with the growth of large… management companies, owners often find that a hotel management company, with its wide range of personnel, can provide managers with the exact experience they are looking for.”
• “Sometimes, the hotel owner negotiates an agreement that ties the management company’s compensation… to the hotel’s actual operating performance.”
• “It can take months or even years to turn an unprofitable hotel into a profitable one. Often, it is the owners of unprofitable… market hotels that seek the assistance of management companies.”

Some of the practices that management companies formerly engaged in have resulted in lawsuits and, in some cases, large damage awards.

The first case of significance involved an owner/management dispute [Woolley v. Embassy Suites] in 1991. This was the first case that established management companies as agents owing a fiduciary duty to the owner(s). Under a hotel management agreement the owner is the principal and the management company is the agent. Courts have long recognized the common law principle of fiduciary duties, specifically the duties of loyalty, good faith, fair dealing, full disclosure, and due care [Renard and Motley]. Agents must also refrain from engaging in self-dealing, taking unauthorized and/or undisclosed profits, and from using the principal’s property without authorization. In the Woolley case the plaintiffs were the owners and general partners of several companies that owned 22 hotels. All of the hotels were franchised by Embassy Suites and 17 of the 22 were also managed by Embassy Suites under separate management agreements. In December 1989 the owners served Embassy Suites with notices of default of nine of the hotels. The owners alleged that Embassy had materially breached the management agreements by “making expenditures in excess of budget allocations.” The owners sought damages and termination of the management agreements. Embassy then filed five separate actions seeking declaratory and injunctive relief as well as demanding arbitration of the claims made by the owners. The trial court found that terminating the management agreements would cause “irreparable harm to Embassy.” The trial court then issued a preliminary injunction preventing the owners from terminating any of the management agreements. The owners appealed.

It was on appeal of this case that the California Court of Appeals applied the theory of agency law to hotel management contracts. In essence, the court held that “it is a cardinal principle of agency law that a principal who employs an agent always retains the power to revoke the agency.” The court did point out, however, that an exception to this rule would occur when the “agency was coupled with an interest.” This means that the management company would have to show some type of “specific, present and coexisting beneficial” interest in the subject of the agency (i.e., the hotel). This will be discussed in several of the other cases. The court went on to state that “although the agent cannot prevent early termination, it can recover damages if such termination was wrongful.”

To sum up, the Woolley appellate court decision relied on three points. First, the court held that the relationship between the owners and Embassy Suites was one of agency and that the principal retains the unrestricted power to revoke the agent’s authority. Second, the court held that the preliminary injunction “impermissibly called for specific enforcement of personal service contracts.” Finally, the court held that Embassy did not demonstrate the inadequacy of an award of damages for the owners’ alleged wrongful termination [Renard and Motley].