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Being explicit: Indemnity clauses, Part 3

As discussed in the second installment of the series on indemnity clauses, historically management companies wished to be fully indemnified from claims resulting from any negligence or any misconduct connected with the operation of the hotel. However, owners and their advisors have become more sophisticated, and new competitors are more flexible. Accordingly, even the most powerful of the international chains have been forced to compromise.

Now, it is usual for indemnification clauses to exclude situations where the management company was guilty of “gross negligence” or “willful misconduct.” Also, in cases where the management company is in fact guilty of gross negligence or willful misconduct, most agreements today require that the management company must indemnify the owner.

This still seems unfair, since the management company is operating the hotel and should in theory be fully responsible for any negligence or misconduct of the hotel’s employees (in President Harry Truman’s words, the “buck should stop” with the management company).    However, this unfairness is largely mitigated by insurance arrangements that are put in place.

Management agreements require that liability, crime and fidelity insurance be maintained, and the cost is an operating expense of the hotel. These policies are usually issued by local or regional insurance companies, with coverage levels as recommended by the management company.

In addition, most management companies, at least the larger ones, arrange for “umbrella” insurance covering all hotels in the chain; if the hotel’s local insurance does not fully cover a claim, the umbrella policy will kick in. The cost of the chain-wide umbrella policy is allocated to each hotel in the chain according to a “reasonable” formula, such as the number of rooms in a hotel as compared to the total number of rooms in the chain.

Thus, it is rare for either an owner or a management company to pay a claim from its own pocket (aside from any deductible). A claim would need to be very large indeed to exceed the two layers of insurance covering the hotel.

The main area of exposure relates to the structural integrity of the hotel.  This exposure was highlighted by the famous Hyatt Regency Kansas City incident, where in 1981 a crosswalk linking two wings of the hotel collapsed, resulting in the deaths of 114 persons, injuries to 216, and massive claims for compensation. Liability for this ultimately rested, however, with the engineering firms involved in the construction of the hotel and, as far as this writer can determine, neither the owner nor the management company were required to pay damages. However, the result may have been different if the bridge collapse had been the result of bad maintenance, or if warning signals had been ignored.

Although the presence of adequate insurance will in most cases prevent an out-of-pocket loss to the owner, to fully protect the owner it is recommended that a provision such as this be put into the management agreement:

“The Owner shall not be liable to indemnify and hold harmless the Management Company from any liability that results from the [gross] negligence or [willful] misconduct of the Management Company, and the Management Company shall indemnify and hold harmless the Owner from any such liability.  The foregoing shall not be construed as limiting the Owner’s right to pursue its contractual damage remedies against the Management Company with respect to amounts paid by the Owner to one or more third parties in connection with the negligence or misconduct of the Management Company, or in connection with any material event of default by the Management Company.”

Clever lawyers may find ways to expand this simple clause into three pages of verbiage, but based upon my 40 years of practice, not much more articulation is needed.

Of course, with respect to liability for the management company’s negligence or misconduct, the ultimate weapon an owner has to use against a management company is the right of termination. Thus, as further protection against gross (or continuing) negligence or willful (or continuing) misconduct by the management company, such behavior can be made a specific event of default. Arguably gross (or continuing) negligence, or willful (or continuing) misconduct, would be a breach of the management company’s implied duty of care and therefore a breach of contract in any event, but there is no downside to being explicit.

 


Contributed by Michael Evanoff, Marlborough Hospitality Services, Singapore

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