The illusory indemnification - Insights

The illusory indemnification

Indemnification The major US hotel brands (e.g., Marriott, Hyatt, Hilton, InterContinentalÉ) have become truly global in the past 20 years and many of them now franchise or manage more hotels outside the US than within the US. In the management agreements whereby these brand owners not only license their names and know-how for use by a hotel, but also oversee the day-to-day operation of the hotel, the management company assumes, and insists upon, the exclusive right to hire, train, supervise and, as necessary, terminate the employment of, all hotel-based personnel.Ê

In the franchise world, employees based at the hotel are employees of the hotel owning company, no matter where the hotel is located, with the franchisor having no hiring or supervisory role, although the franchisor may make training programs available to certain hotel personnel.ÊIn the management agreement context, the situation is less uniform.

In the US, the management companies generally insist upon being the employer of each and every hotel employee. The hotel-based employees receive pay checks from the management company and participate in their nation-wide benefit plans.Ê There are enormous synergies and policy uniformity that are achieved by making the hotel-based personnel at all levels employees of the management company rather than the hotel owning company.ÊEven so, the recruitment and relocation costs, training costs, salaries and benefits, and termination-related payments are all above-the-GOP-line operating expenses of the ÒhotelÓ which means that they are borne by the hotel owner as routine operating expenses.

Outside the US, the employer/employee relationship is very different. Typically, all hotel-based employees are expressly required in the management agreement to be employees of the ÒhotelÓ and therefore they are employees of the hotel owning company and not the management company.ÊThe key personnel, such as the General Manager and other members of the hotel’s executive committee, may be employees of the US-based management company (e.g., Marriott),Êbut while they are serving at the non-US hotel, they are also on the hotel’s payroll as employees of the hotel owning company and at least part of their salary is in local currency. They may also remain participants in the management company’s benefit plans and may draw a dollar-denominated salary in the U.S. from the management company that is a charge-back to the hotel owning company, with the benefit of tax-free US income for residents working abroad, currently $101,300.

Why this distinction? While not articulated in the management agreement, the motivations of the management companies seem to be (a) to avoid having a tax ÒpresenceÓ in the many non-US jurisdictions where they manage hotels and (b) to avoid the complexity of compliance with the local employment law regimes in each such jurisdiction.

What about liability for acts of employees under supervision of the management company?ÊWhether in the US or not, the management agreements slavishly follow the limited indemnification obligations as follows.ÊThe hotel owning company must indemnify, defend and hold harmless the management company from all liabilities arising at the hotel, no matter that the employees are selected, trained, supervised and disciplined by the management company. The exception is for gross negligence or willful misconduct on the part of the management company in which event the indemnification obligations runs in the opposite direction, i.e., the management company will indemnify, defend and hold harmless the hotel owning company. While this may seem an unreasonable allocation of risk, it has become the industry standard, at least based upon my own experience and that of other lawyers who represent owners and management companies in the negotiation of hotel management agreements.ÊBut at least the management company is protecting the hotel owning company from those truly grossly negligent or willful acts attributable to it that may arise in the course of managing a hotel, such as grossly negligence in hiring (possibly where no background check is done when a rapist is hired) or in day-to-day operations (possibly when a slippery wet floor not cordoned off) or in employee discipline (possibly where an employee is terminated based upon age, race, religion or other protected classification).ÊWhile the management company will stand behind these really bad acts of its employees in the US, what is the result where the employees Ð including all supervisory personnel and rank-and-file personnel – are employees of the local owning company?

Outside the US where all employees at a hotel are employees of the hotel owning company, the indemnification obligation of the hotel management company becomes much less certain and even illusory. The argument can be made that anything that takes place at the hotel, whether ordinary negligence, gross negligence or willful misconduct, is not attributable to the hotel management company because it is not even present at the hotel. In fact, one can question how the management company can even perform its day-to-day supervisory role without any employees at the hotel. The best that can be argued by the owning company is that those employees assigned by the management company to serve at the hotel for a time, remain employees of the management company.Ê But these employees may have no involvement in the acts in question. Consequently, the indemnification can be illusory.

So, what to do?

1. The first line of recourse for almost all liability arising at any hotel is the general liability insurance policy. By naming both the management company and the hotel owning company as named insureds, both parties are protected no matter who technically bears responsibility under the management agreement,Ênaturally with the caveat that the deductible will have to be allocated. The next two approaches will deal with uninsured losses or deductibles.

2. A second approach to the problem is to provide that all acts of the hotel’s key personnel, no matter whose employees they are, are attributable to the management company.ÊThe key personnel typically are hired and trained by the management company and some may be assigned to the hotel for a time, and then move on as itinerant management company personnel to other managed hotels. It is logical and fair that the conduct of all key personnel within the scope of their employment should be deemed to constitute conduct of the management company.

3. A third approach is to provide that any liability arising as a consequence of a policy or procedure promulgated by the management company is attributable to the management company.ÊIt is the management company’s inadequate Òknow-howÓ that caused the problem and it should be responsible.

If a hotel owner is contracting for more than the brand and reservation system (as in franchise agreements), but is looking to the management company to Òsupervise, direct and control the day-to-day operation of the hotelÓ (as is typically stated in management agreements), then the allocation of liability for matters arising at the hotel should be the same whether the hotel is in the US or not and certain acts must be attributed to the management company as set forth in numbers 2 and 3 above.ÊNegotiation of these matters before the management agreement is executed will protect the hotel owning company and, in my view, fairly allocate risk, while not disturbing the now generally accepted principle that the management company will not protect the owning company from the results of ordinary negligence because Òstuff happensÓ even in the best managed hotels and insurance is there for these kind of risks.ÊBut uninsured losses and deductibles should be allocated in a rational and consistent matter.

By Albert J. PucciarelliÊ

Albert PucciarelliAlbert J. Pucciarelli is a partner in the law firm of McElroy, Deutsch, Mulvaney & Carpenter, LLP.ÊHe is Chair of the firm’s Hotels and Resorts and Aviation Practice Groups. From 1988 through 1998, he was a Director and Executive Vice President, General Counsel and Secretary of Inter-Continental Hotels. He has served as Chair of the Hotels, Restaurants and Tourism Committee of the Association of the Bar of the City of New York (2001-2004) and as Chair of the Aeronautics Law Committee of the Association of the Bar of the City of New York (1998-2001). He is a Director and immediate past President of the Hospitality Industry Bar Association. He has taught International Business Law as an adjunct professor at the Fordham University Graduate School of Business, and was member of that school’s Advisory Board (1996-2004). He is a member of the Cheyney University of Pennsylvania Hotel, Restaurant & Tourism Management Board. He is a Director of Skytop Lodge Corporation in Skytop, Pennsylvania, and a consulting member of Cayuga Hospitality Associates.Ê

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