November 30, 2017
Many first-time hotel developers are surprised to find out that the management agreement with the brand needs to be finalized long before the hotel is built and open for business. Lenders will not usually fund a construction loan until the brand management agreement is in place, so developers have to negotiate and finalize the agreement before the first pile of dirt is moved. But how does such an agreement work with respect to a hotel that does not yet exist?
This issue is resolved in an addendum to the management agreement that governs the obligations of brand manager and owner between the closing of construction financing and opening of the hotel, usually titled Technical Services and Pre-Opening Addendum (TSA) or similar name.
The TSA is composed of two main sections:
Technical services: This section governs the construction phase and details the types of plans and specifications for the new hotel, along with construction milestone deadlines, that must be submitted by the owner to the manager for approval.
Pre-opening: This part of the TSA governs the 12 months prior to the hotel opening, setting forth the actions that manager will take (at the owner’s expense) to get the hotel operationally ready for opening, such as hiring staff, marketing, pre-selling rooms, etc.
The brand manager seeks to accomplish several things in the technical services portion of the TSA. First, the TSA sets forth the owner’s obligation to provide design and construction plans to the manager at every stage of the process, from conception to final plans and specifications, so that the manager can confirm compliance with brand standards. In addition, the manager requires approval rights over the general contractor and other major project consultants. The TSA also sets forth the owner’s obligation to build the hotel in accordance with the manager-approved plans on a timely schedule.
In negotiating the TSA, the owner’s overriding concern regards certainty as to what the owner is obligated to build, and how much time the owner must give the manager to review the plans presented by the owner. It’s important for the owner that the TSA lock down brand standards. Without specifying the version of brand standards, brand requirements could evolve, forcing the owner to make costly and time-consuming changes during construction.
For similar reasons, it is important to the owner that the TSA establish a “one bite at the apple” rule regarding manager approval; that is, once the manager has approved a certain set of plans, such plans are thereafter deemed to be in compliance with brand standards. Finally, the owner will want the manager to have a deadline to approve or disapprove (in the case of disapproval, with a list of specific reasons) the submitted plans. This deadline could range from 15 to 45 days, depending upon the type of submittal.
The pre-opening section of the TSA is devoted to the actions that the manager will take during the six to 12 months before the scheduled opening of the hotel. The owner is responsible for funding all pre-opening expenses and the manager’s fee for these services. This section typically requires the manager to have the final say about when the hotel is authorized to open under the manager’s brand.
Again, the owner’s primary concern is with respect to certainty. The owner should require that all pre-opening expenses be subject to a budget agreed to by the owner and manager at the time the TSA becomes effective, and that the owner have reasonable approval rights over any material variances from the budget.
The owner should also require that the manager be subject to a “reasonableness” standard for authorizing the hotel to open under the manager’s brand – for example, by permitting non-material corrections and/or punch-list items to be completed in the months after opening. And in cases potentially involving a dispute between the manager and owner, the owner should insist the TSA contain a clearly defined dispute resolution process, since lawsuits are not practical in a construction context if the owner wants to stay on schedule.
The process of successfully planning, financing and executing a new hotel development involves thousands of details to manage and issues to resolve, of which the TSA is only one. The TSA is often relegated to the bottom half of the development checklist behind more immediately pressing matters such as feasibility studies, site acquisition, design and financing.
But the TSA actually becomes relevant much earlier in the development process than generally understood. Developers who want to bring projects in on time and under budget should consider making it a higher priority. Don’t make the mistake of thinking “addendum” is Latin for “afterthought”!