Part Three 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 2660 Woodley Road Joint Venture v. ITT Sheraton Corporation

v.

P.T. Karang Mas Sejahtera v. Marriott International Inc., et al

By Meg McDonough

March 2008

President, Luxury Hospitality Consultants, LLC

The next case that will be discussed is 2660 Woodley Road Joint Venture v. ITT Sheraton Corporation (villanova.edu). This case is unique in that it involved the owner’s use of the agency relationship to sue for breach of fiduciary duties and other torts. This case is also unique in that it was a jury trial that resulted in a substantial damage award. Sheraton Operating Corporation, a wholly-owned subsidiary of ITT, had managed the hotel on behalf of Woodley Road (owner) since 1979. In return for its management services, Sheraton was to receive compensation based on a percentage of the gross revenues plus a percentage of net cash flow as an incentive fee.

The management contract was set to expire in 2000; however, it did contain three successive 10-year renewal options. Under Sheraton’s management the hotel developed a capital deficit. The owner retained counsel to investigate how the deficit had developed. As a result of its inquiry, the owner ultimately terminated the management contract and the operating company’s agency under that contract. The management contract and agency were terminated and revoked on July 31, 1997. On August 1, 1997, the plaintiffs filed suit seeking monetary damages and equitable relief. The termination of Sheraton’s agency became effective on August 18, 1997. However, the company refused to vacate the premises and contested the termination of the management contract and revocation of the agency. In its complaint, the owner alleged that Sheraton had behaved illegally in the following ways:

• obtaining kickbacks from vendors providing goods and services to the hotel;
• engaging in a pattern and practice of diverting and misallocating hotel assets to the financial gain of Sheraton;
• engaging in self-dealing transactions in mismanaging the hotel, in some cases by diverting hotel facilities and services to the personal use of Sheraton’s officers, directors, employees, and affiliates;
• failing to obtain consent for major hotel expenditures, including service contracts with affiliates; and
• engaging in or condoning account and tax payment irregularities [Renard and Motley].

The owner asserted that these acts constituted breach of contract and breach of fiduciary duty as well as violations of RICO (Racketeer Influenced and Corrupt Organizations) and anti-trust statutes [Renard and Motley]. The owner’s complaints centered on Sheraton’s attempts to increase its own profitability during a period of time when the hotel was not expected to make money. The incentive fee outlined in the management contract was unlikely to be paid and the owners alleged that Sheraton engaged in these improper practices in order to ensure that it earned a profit, even if the hotel did not.

On February 4, 1998, the District Court of Delaware issued the preliminary injunction. Unlike the previous cases outlined in this paper, both parties agreed that agency law governed the termination of the management contract. The only issue before the District Court was “whether the agency was given as a security qualifying as an agency coupled with an interest” [Renard and Motley]. As previously discussed, this is the exception to the general rule of agency revocability. Sheraton’s agency theory failed because the operating company had no interest independent from its agency powers under the contract. The court found that Sheraton’s argument was without merit. The court also held that Sheraton’s refusal to vacate the premises was delaying the approval of a multi-million-dollar program of renovations to the hotel. The court ordered Sheraton to vacate the hotel within one week.

On December 10, 1999, a jury handed down a verdict against Sheraton for damages in the amount of $50,088,000. The jury’s verdict in favor of the owners was based on the following claims:

• an anti-trust claim under the Robinson-Patman Act [Butler and Riffer];
• three of the plaintiffs’ eight breach of contract claims (breach of fiduciary duty, breach of implied covenant of good faith and fair dealing, and intentional or negligent misrepresentation); and
• punitive damages [Renard and Motley].

The jury declined to find Sheraton liable for fraud or a RICO-style conspiracy. The jury awarded compensatory and other damages of approximately $12.6 million and roughly $37.5 million in punitive damages. Two years after the initial ruling, the district court affirmed the jury’s findings but reduced the amount of punitive damages.

The final, and most recent, case presented is P.T. Karang Mas Sejahtera v. Marriott International Inc., et al. (Carter) This suit was filed July 18, 2005 and was settled January 25, 2008. The suit accused Ritz-Carlton LLC and its owner, Marriott International Inc., of fraud, breach of contract, and breach of fiduciary duty. The plaintiff (hotel owner) found out in 2004 that the Ritz-Carlton group had been engaged to operate a new luxury resort just a few miles from the plaintiff’s hotel. The complaint alleged that Ritz-Carlton abused its privileges and used confidential and proprietary information owned by the plaintiff to plan and develop the competing hotel. The plaintiff specifically alleged that Ritz-Carlton operated a competing property in disregard of the plaintiff’s territorial rights. A nine-person jury in The United States District Court in Greenbelt, Maryland, reached a unanimous decision that Ritz-Carlton violated its fiduciary duties. The jury awarded the plaintiff $382,000 in actual damages and $10 million in punitive damages [Farmer and Kearney]. The punitive damage award was actually twice what the plaintiff requested. The verdict also allows the plaintiff to pursue millions more in attorneys’ fees.

As the cases discussed in this paper show, judges and juries are no longer viewing management contract disputes as simple contractual matters. Beginning with Woolley, courts are now viewing all management contracts and even franchisor / franchisee agreements as establishing agency relationships subject to agency law. In simple contract cases punitive damages are usually not awarded. Contract law simply compensates the injured party. It does not punish the breaching party. Agency law, however, does allow for the awarding of punitive damages. As the recent Ritz-Carlton-Bali case has shown, punitive damages can be substantial.