By Andrew MacGeogh, HOTEL Asia Pacific Legal Correspondent
ATROCITIES in the US and Indonesia have focused the hotel industry’s mind on the “terror risks” of doing business, with both owners and managers facing unprecedented challenges. But what is their legal status should the unthinkable happen at one of their properties?
This article considers the liability of owners and operators in respect of such risks in a typical hotel-management contract.
Over the past two years, one defined term and certain “esoteric provisions” in these agreements have achieved “special-significance status”. I refer, of course, to the force majeure provisions.
These clauses address the circumstances under which the parties to the contract may be excused from non-performance, or may even have the right to terminate the agreement, without liability.
Other provisions, which no doubt have been scrutinised more carefully, are the “damage, destruction and condemnation” clauses which set out the situations where a hotel owner is obliged to repair its hotel if it is damaged.
These provisions have become crucial in allocating the respective liabilities of an owner and an operator if the hotel they own and operate is affected, damaged or even destroyed as a result of a terrorist attack.
Liability for repair
An owner might think that having his hotel destroyed by a terrorist attack would be unfortunate enough. To rub salt into the owner’s financial wound, though, he may actually be contractually bound to repair the property, even if he would otherwise have preferred to turn it to some other use after the tragedy.
The obligation of an owner to repair the hotel under a management agreement usually depends on the extent of the damage. In general, if the costs of repair do not exceed a certain threshold specified in the management agreement [which is usually a certain percentage of the replacement costs of the hotel], the owner will be obliged to repair the hotel to its condition prior to the destruction.
However, if the costs of repair exceed the specified threshold, the owner will have the right to choose not to undertake the repair and to terminate the management agreement.
Another threshold may also be negotiated in respect of the obligation to repair when the damage is not covered by insurance. The determination of these thresholds is a matter for the owner and operator to negotiate.
What if the hotel is “appropriated”?
In a dramatic case in which a hotel is “appropriated” by an army, hostage situation or other “forceful authority”, an owner will generally have the right to terminate the management agreement if the hotel is taken for a long period of time, as specified in the agreement [eg, 12 months].
If the length of “appropriation” is shorter than the specified period, the obligation of the owner to repair and reinstate the hotel after the “appropriation” will usually depend on the cost of repair, as discussed above.
Query also whether the term of the contract should be extended in such circumstances by the period of “appropriation”.
The damage caused by terrorism to the hotel industry are far more extensive than mere physical property damage. The impact of the recent bombing outside the JW Marriott Jakarta has had an impact on the hospitality industry in Indonesia, which is still struggling to recover from the aftermath of the Bali bombing and the more recent problems caused by SARS.
During the downturn of local, regional and global tourism - with the resulting decreased turnover and revenues - an owner, typically, will be most concerned as to how operating expenses can continue to be funded.
Generally, in most hotel-management agreements, there is no limitation on the owner’s obligation to fund working capital. In other words, there is an open-ended requirement on the owner to contribute.
Very often, an owner is unable to rely on the force-majeure clause to avoid or delay making such contributions. Most force-majeure provisions would not excuse a failure to make any monetary payments, even when unforeseeable and uncontrollable events occur.
Having said that, it is worth pointing out that force-majeure clauses, like all other provisions, are meant to reflect the intentions of the parties, and can be drafted and/or varied as they wish - no doubt following prolonged negotiation of these terms.
From an operator’s perspective, when a hotel’s business is affected by terrorism, a direct and immediate consequence is the reduction of management fees, which are usually calculated on the basis of gross revenues or gross operating profits.
Quite apart from that, the operator might also have to face the pressure of meeting the performance tests or guarantees set out in the management agreements. In many agreements, there is a requirement for operators to meet minimum-performance standards or performance guarantees, and a failure to do so may entitle the owners to terminate the management agreements.
Obviously terrorism has caused a number of hotels around the world to fall short of these agreed performance targets.
Performance-test-related provisions which are carefully drafted, however, would usually provide some “reasonable” exceptions under which the operator will not be held responsible for a failure to meet the performance test. These exceptions generally include:
Loss of business due to major renovations of the hotel;
Failure to meet targets due to force majeure events; and
Where failure is attributable to any event of default by the owner.
Any reasonable force-majeure provision would also cover acts of terrorism.
In some management agreements, in addition to the exceptions briefly described above, operators may also have the choice of avoiding termination by making a “Cure Payment” - or some other payment - to meet any shortfall due under the performance guarantee.
Liability towards guests
If a hotel is destroyed by acts of terrorism, another issue which owners and operators might have to tackle is potential claims brought by guests for injuries caused.
Generally, neither the operator nor the owner would be held liable for any injury or death caused by terrorist activities, unless the owner or operator has failed to exercise reasonable care for the safety and security of their guests.
Therefore, to make sure that the reasonable-care standard is met, it is necessary and advisable for owners and operators to take reasonable and necessary steps to protect the safety of guests, including implementing appropriate security policies and measures and providing crisis-management training to all employees.
Is insurance the answer?
The events of 9/11 have brought significant changes to the insurance industry. While it is generally still possible to obtain terrorism insurance coverage in the market, the high cost of such coverage in some countries has driven many hotels to reluctantly raise their risk tolerance level and forego such insurance coverage.
Of course, this means that when a hotel incurs any liability arising from terrorist attacks, these liabilities - which could be enormous - will be borne entirely by the owner unless the government of the country in which the hotel is located steps in to meet this liability or to provide other financial support.
While contract and insurance might address some issues relating to terrorism, they are not perfect solutions.
To protect their own interests, operators and owners must apply more resources and attention to safety and security issues to minimise the risks of terrorist attacks in their hotels, or at least mitigate the damage in the unfortunate occurrence of such attacks.