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Punitive Damages 3 of 3

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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.

Punitive Damages 2 of 3

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Part Two 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 Pacific Landmark Hotel, Ltd. v. Marriott Hotels, Inc.

v

Government Guarantee Fund of the Republic of Finland v. Hyatt Corporation

By Meg McDonough

March 2008

President, Luxury Hospitality Consultants, LLC

The next case discussed is Pacific Landmark Hotel, Ltd. v. Marriott Hotels, Inc. [Renard and Kristi]. This case is unique in that the management agreement specifically stated that Marriott’s agency was “coupled with an interest and may not be terminated by owner until the expiration of the term of the agreements.” The stated term of the management agreement was sixty years. At about the same time that the management agreements were put in place, the owners of the hotel secured loans with several of Marriott’s subsidiaries totaling approximately $23 million. The lenders secured these loans by deeds of trust and collateral assignments of the management agreements. In effect, the security for these loan transactions may have created an “interest in the hotels,” thereby preventing termination of the management agreements. The trial court did find, in part, that “Marriott was an agent coupled with an interest” and that the owners could not terminate the agency. The court denied the owners’ motion for a preliminary injunction. The owners appealed. The specific issues before the California Court of Appeals were whether the owners had the statutory power under California Civil Code § 2356 (a)(1) to terminate Marriott as their agent or whether Marriott’s agency was “coupled with an interest in the hotel”, thus making the management agreements irrevocable (Renard and Motley). The court relied on the Woolley decision in holding that the management agreements created an agency relationship between the owners and Marriott and that the owners retained the power to revoke the agency, unless the agency was coupled with an interest. As mentioned earlier, the management agreements specifically stated that Marriott’s agency was “coupled with an interest and may not be terminated by owner.” However, the court again looked to Woolley for the definition of “an agency coupled with an interest.” The court found that the parties had not created an agency with an interest, despite the provisions of the management agreements. The court held that “even if the parties intended to create an irrevocable agency, one coupled with an interest, unless they do so and such an interest does in fact exist, the statutory power to revoke may be exercised.” Marriott had argued that the prior loan agreements with its affiliated companies did, in fact, create an “interest.” The court held differently, however, in ruling that Marriott itself did not have an interest that would have created an irrevocable agency.

This next case, Government Guarantee Fund of the Republic of Finland v. Hyatt Corporation, is a federal appellate decision that brought agency law into the federal arena (U.S. Court of Appeals for the Third Circuit, No. No. 96-7288). The owners of the Hyatt Regency on St. John, U.S.V.I., entered into a management agreement with the Hyatt Corporation in March 1990. Hyatt Corporation agreed to manage the resort in exchange for a share of the long-term profits. The initial management agreement was for a 30-year term which included restrictive cancellation provisions. Prior to the execution of this agreement, the owners of the hotel obtained a loan for approximately $120 million from Skopbank, a Finnish corporation (Renard and Kristi). Hyatt Corporation also entered into a subordination agreement (providing for continued occupancy should a subsequent owner take over) with Skopbank in the event the hotel owners defaulted on the loan. The owners, in fact, did eventually default on the loan, and Skopbank filed a foreclosure action in the District Court of the Virgin Islands in 1991. Subsequent to the foreclosure filing, Skopbank itself began to fail. Government Guarantee Fund acquired a controlling interest in Skopbank as part of the Finnish Government’s bailout plan.

On February 1, 1995, the District Court put the hotel up for judicial sale. On March 20, 1995, 35 Acres Associates acquired the hotel. The new owners (35 Acres Associates) then informed Hyatt that its management agreement was terminated. Hyatt refused to vacate the hotel and surrender the keys. In March 1995, Government Guarantee Fund and Skopbank filed suit against Hyatt alleging breach of the management agreement and other causes of action. The plaintiffs sought declaratory judgment giving them possession of the hotel. Later, in November 1995, Government Guarantee Fund and Skopbank amended their complaint and included 35 Acres Associates as plaintiffs. Hyatt countersued 35 Acres Associates, Government Guarantee Fund and Skopbank. The District Court consolidated the two cases for trial. The court, in a non-jury trial ruled in favor of the plaintiffs and granted 35 Acres Associates possession of the hotel. Hyatt appealed to the Third Circuit Court of Appeals. “The Third Circuit held that a contractual provision created to prevent early termination is effective only to create liability for such wrongful termination”. It further held that the “only exception to the principal’s ability to terminate an agency relationship at any time (as expressed in Pacific Landmark) is when the authority granted to the agent is a power given as a security.”

Essentially, the court said that the agency relationship itself does not establish or create an interest. “The agency merely serves to protect the separately granted or created interest when the two are coupled.” After establishing that 35 Acres Associates rightfully terminated the agency relationship with Hyatt, the district court held that Hyatt could not continue to manage the hotel. The court did not address the issue of “wrongful termination” for which Hyatt could have been awarded damages.

Punitive Damages 1 of 3

Published by

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].

Insights

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Insights on Interacting with Busy Executives

Meg McDonough, President of Luxury Hospitality Consultants LLC in Sarasota, Florida, is a regular contributor for HospitalityEducators.com. She recently completed an in-depth interview with the Executive Pastry Chef at one of the best-known hotel brands in the world, and we wanted to share some additional background with our readers on how these interactions come to be.

John Hogan, Co-Founder of HospitalityEducators.com

Interview with Guillaume Marchand

Ritz Carlton-Sarasota Hotel

The Challenges of a Pastry Chef

Q.  Why did you choose Chef Marchand?   

I came across his creation of the Gingerbread Mansion while attending the Winefest celebration held in Sarasota. Chef and his team fashioned a built-to-scale edible masterpiece fashioned after the real mansion which John Ringling built for himself and his wife in Sarasota as their winter residence. The home is called Ca d’Zan (“House of John”) and is located on the John and Mable Ringling Museum grounds. The home was also used for the filming of a more recent version of “Great Expectations” starring Gwyneth Paltrow, Ethan Hawke, and Anne Bancroft (to name a few).

Q. What was special about this particular Chef?   

Chef Marchand had previously worked for the Ritz-Carlton in Barcelona and I wanted to learn about the challenges he has encountered while working in a different country. I find the cross-cultural aspects when dealing with food preparations to be of interest. As my interview will show, he will soon be undertaking a new assignment in Dubai for the Ritz-Carlton. This, to me, is so propitious for career-minded professionals who are talented and skilled in their trade and get to see the world.

Q. What is the one thing readers will take away?     

The amount of time one is willing to devote to a skilled trade, in this case – pastry arts, will always take time and patience. I think the apprenticeship route is most typical for European-based chefs and the level of schooling adds to the incredible opportunities that will come forward. Talent, temperament and outright professionalism will determine one’s chosen path.

The various high-end hotel brands, in general, provide excellent avenues for talented personnel and executives to transfer within their chains and this, in my opinion, has great appeal for those individuals seeking the experiences and challenges one finds in working in different locales around the world. I’ve also been cognizant of the fact that when the culinary staff works together cohesively as a team, they heed the best in service marks overall.

Utmost in my search for quality standards within the hospitality industry is the calibre of respect employees have for one another and this was quite evident at the Ritz-Carlton. They pride themselves on self-leadership qualities. They are trained with a professionally mastered seven-week orientation course before they are even hired. Chef Marchand is on mark.

Q. Is the hotel or the chef the center of the message?

Chef Marchand becomes my model of a dynamic employee who fosters intelligence with accomplishments in a continuing growth pattern. It’s so energizing to see such vitality when someone has talent and they are more keen to share it with the rest of their “creative team” in the kitchen. He is both instructor and a continuing student himself – I think that’s the dynamic message. Growth never stops when one gets to the top (there’s always another door to go through).