During the course of negotiating an agreement between the owner of a hotel and a hotel operator, franchisor, or manager, one of the principal points of negotiation is the agreement’s term. Over the course of the last few decades, however, numerous cases have held that, without regard to the term set forth in the agreement, a hotel owner always maintains the right to terminate a management agreement, even in the absence of a breach of the agreement by the manager. These cases, however, may not be applicable in Maryland, which has a unique statute that provides hotel managers and operators with the ability to enforce the term negotiated by the parties in the management agreement.
Historically, hotel owners managed their properties directly. Over time, however, as hotels began to be franchised, the management and ownership of hotels began to be separated, and hotel owners contracted out the management of their hotels to hotel franchisors, operators, or managers. Often, these hotel management agreements had very long terms, and hotel operators and managers took the position that the owners did not have the right to terminate the management agreement, unless and until there was a material breach of the agreement by the manager.
A line of cases has developed, however, suggesting that a hotel owner always maintains the right to terminate a management agreement, without regard to the term the parties negotiated and without regard to whether the manager breached the agreement. These cases typically rest on two legal principles. The first is that the hotel management agreement constitutes an agency agreement and that, pursuant to a cardinal principle of agency law, a principal always retains the power to revoke the agency. An exception to this is where the agency is coupled with an interest. However, courts have scrutinized management agreements and have held that the agreement does not, by itself, create a sufficient interest in the agency to permit hotel operators to come within this exception. See, e.g., Pacific Landmark Hotel, Ltd v. Marriott Hotels, Inc., 23 Cal. Rptr. 2d. 555 (4th Dist. 1993).
The second legal principle that Courts have employed to determine that hotel owners always maintain the right to terminate hotel management agreements is that the agreements constitute personal services contracts. For example, in Marriott International v. Eden Roc, the Appellate Division of the Supreme Court of New York reviewed the management agreement between the hotel owner and the hotel manager and determined that the agreement “places full discretion with [the manager] to manage virtually every aspect of the hotel.” The Court found that such an agreement “is a classic example of a personal services contract that may not be enforced by injunction.”
Unsurprisingly, hotel owners have lauded these decisions as vindicating the right of hotel owners to remove managers from the hotel in their sole discretion, even if the management agreement provides for a lengthy term and there was no material breach of the agreement. It should be noted, of course, that management agreements may provide for damages to be awarded to the hotel manager in the event of such a termination, and that nothing in these cases prevents these damages from being recovered. Nevertheless, the holdings in these cases represent a significant advantage for hotel owners.
Notwithstanding this line of cases, a Maryland statute has the potential to substantially limit an owner’s ability to terminate a hotel management agreement. Section 23-102(a) of the Commercial Law Article of the Annotated Code of Maryland states that “[i]f a conflict exists between the express terms and conditions of an operating agreement and the terms and conditions implied by the law governing the relationship between a principal and agent, the express terms and conditions of the operating agreement shall govern.” An “operating agreement” is defined as a “written contract, agreement, instrument, or other document between at least two persons that relates to the management, operation, or franchise of a hotel . . . .” Md. Code Ann., Com. Law III § 23-101(c). The statute further provides that a Court may grant specific performance for an anticipatory or actual breach or attempted or actual termination of an operating agreement even if an agency relationship exists between the parties. Id. § 23-102(b). Operating agreements are enforceable for the term set forth in the agreement unless the agreement contains a right of early termination. Id. § 23-104. Clearly, this statute represents a significant challenge to hotel owners with hotel management agreements governed by Maryland law who desire to terminate an agreement.
It should be noted that the Maryland statute has never been challenged in Court. Hotel owners and their lawyers have publicly taken the position that the Maryland statute may not survive constitutional scrutiny. Most notably, lawyers representing hotel owners have argued that the enforcement of the statute would violate the Thirteenth Amendment of the United States Constitution because, by enabling managers to compel the performance and acceptance of personal services under threat of injunction, the statute constitutes the compulsion of involuntary servitude. Owners for hotel owners have also argued that the statute constitutes a taking without just compensation in violation of the Fifth Amendment, because it imposes the forced occupation of a hotel by a terminated manager without regard to the property rights of the hotel owner, and that the statute violates the Contracts Clause of the United States Constitution, because it alters the contractual arrangement between the parties by eliminating a principal’s right to revoke its agency and authorizing specific enforcement of a personal services contract.
It certainly bears continued review to determine if any hotel owners challenge the constitutionality of the Maryland statute. To this point, however, the statute provides significant protections to hotel managers and operators working under management agreements governed by Maryland law.
As always, any party negotiating a hotel management agreement or a party to such an agreement who is in need of assistance is invited to contact Ferguson, Schetelich & Ballew at 410-837-2200.