Smoothing the Legal Path to Development

Successful development of a pure hotel or the currently favored mixed-use project is a delicate blend of business, finance, marketing and law. The challenging legal issues fall into three main categories: issues between the developer and management company; loan issues among the developer, the lenders and the hotel management company; and local legal and political issues.

Negotiating the management agreement starts with a letter of intent, followed by the hotel management company's drafts based on their forms. Although these agreements have become more balanced in recent years, they still require substantial negotiation. Negotiating the management company's incentive fee requires experienced counsel. While the standard is a percentage of operating profit, the developer should instead consider negotiating a fee based upon net income after debt service, or at least a fee that is subordinated to or deferred after payment of debt service or some agreed amount of owner's priority return.

Developers should insist on a challenging performance test that allows removal of a non-performing management company without a termination payment or unlimited cure rights.

The agreement should include a non-competition provision that provides real protection against the management company's operation of a competing hotel. The performance tests in the standard text of an agreement can be illusory and must be carefully scrutinized.

With the proliferation of mixed-use hotel projects, agreements relating to non-hotel components have become more standard across hotel brands. Familiarity will speed final execution without the numerous intervening drafts common in the past with these kinds of projects.

Likewise, loan agreements — particularly where a major multi-national lender is involved — are very similar for all projects, wherever they're located. Local law and practice will govern security instruments, such as mortgages and pledge agreements.

Sometimes the hotel management company is a lender whose loan is subordinated to the senior loan and secured by a second mortgage, resulting from cash advances or payment deferrals in the development stage or after completion. Where condominium or other residential units are built and sold before the hotel's completion, provision must be made for the release of the lenders' liens on residential units as they are sold and possibly for the sweep of the proceeds to reduce the outstanding principal on the loans.

Clarity and cooperation are essential regarding the respective roles of local counsel and the brand or developer counsel. For example, local counsel must be able to secure positive, on-going support for the project at all relevant levels of the local government, and where necessary, effect changes in local law.

Guidance from local counsel is also critical regarding local land use regulations, employment law, permitting, construction agreements, condominium structuring, tax and available tax incentives and other concessions, as well as a perspective on local competition, both existing and planned.

Local counsel can serve the developer in ways an outsider cannot, and it is best if the local firm is employed directly by and has a strong relationship with the developer, rather than just serving in an ancillary role to the developer's hotel lawyer.

The developer must also be able to rely on the local lawyer for review and adaptation, as necessary, of the loan security documents, such as mortgages and pledges.


Albert Pucciarelli, Esq., is chair of the Hotel and Resorts Practice Group of McElroy, Deutsch, Mulvaney & Carpenter, New Jersey's third-largest law firm, headquartered in Morristown, NJ. Previously, Pucciarelli was executive vice president and general counsel of InterContinental Hotels and Resorts and a member of its board of directors. He can be reached at 201-493-3718 or apucciarelli@mdmc-law.com

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