Crowded House: Examining AOPs in the age of brand proliferation

It’s getting more congested out there.  

Brand companies have expanded their offerings in recent years through a variety of mergers and acquisitions and organically. Though brand proliferation has increased the options available to hotel owners and consumers, it, too, has an attendant consequence: multiple brands within a brand company sharing similar room counts, amenities and price points. Subsequently, despite the congruity, different brands within a company might compete with one another without running afoul of the area of protection (AOP) provision within franchise or management agreements. This competition not only potentially reduces revenues for existing hotels, but it also calls into question whether today’s AOPs are still effective in protecting owners from unfair competition within the same company. 

TODAY’S AOP  

AOPs are intended to protect an owner’s expectation that the company that owns their hotel’s brand will not introduce a competing hotel within the specified area. However, AOPs can fall short of achieving this goal for several reasons:  

• Traditionally, AOPs are limited to the subject hotel’s specific brand, geographic area and duration. While an AOP’s geographic area and duration have been negotiable, companies rarely entertain AOPs beyond the subject hotel’s brand. This offers owners no protection against the company’s newly created brands, even when those brands are in the same brand category as the subject hotel and target similar market segments and price points.  

• Companies rarely alter AOP language that allows the company to do a “chain acquisition,” which typically applies to a group of hotels if substantially all of such hotels are merged with or acquired, franchised or operated by the company—even if such hotels fall within the hotel’s AOP. Owners’ remedies are limited when they believe the company’s addition of a property with a different company brand will negatively affect their hotel: Often, a company’s response is to offer an impact study. These studies are usually performed by consultants having an ongoing relationship with the company, which may disincentivize comprehensive and fair studies. Additionally, impact studies may fail to consider the aggregate effect multiple new hotels will have on the market, including the longer period of time it takes the market to absorb the aggregate number of new rooms. Further, while owners are usually required to pay for the impact study, they may never receive a copy nor have the opportunity to challenge it.  

• Litigation is usually prohibited, and arbitration to block the addition of competing hotels is a significant challenge for owners. Often, owners struggle to prove the company failed to abide by the AOP language, which understandably results in an outcome in favor of the company. In the unlikely event of a judgment in favor of the owner, determining the appropriate remedy can be difficult.  

REMEDYING AOPS  

Though the inefficacies of current AOPs and the diverging interests of owners and companies might make revisiting these provisions daunting, today’s era of significant brand proliferation could open the door to altering AOPs in several ways to better protect owners from competing hotels:  

• AOPs could preclude new hotels with characteristics that make them more likely to compete with the hotel for guests, rather than being limited solely to the hotel’s brand. For example, the AOP could restrict the company from adding hotels (regardless of brand) with similar number of keys, square footage of meeting space, amenities, target segments or business mix, target “chain scale” price points and/or brands within the company’s own brand categories. AOPs could also be triggered when a new hotel causes the hotel to be positioned lower in the company’s website search listings.  

• Conditions protecting owners could be added to the AOP exceptions. For example, the chain acquisition exception could be conditioned on the company confidentially presenting the proposed acquisition to a subset of its owner advisory council and proactively addressing that group’s concerns. The provision could be further strengthened by empowering this group to impose obligations on the company if the transaction is consummated, such as payments to, or fee reductions for, adversely affected hotels.  

• Impact studies could be improved by including owners in the selection of the consultant, owner and company jointly engaging the consultant, splitting fees evenly between the owner and the company and allowing owners to review and rebut the study before it is finalized.  

• An owner’s termination right and/or a liquidated damages (LDs) remedy could be added, which would be triggered when a certain number of competing hotels or the number of keys are added. LDs could be based on a fixed amount, such as lost revenues and/or income, or the estimated diminution in value of the hotel. This would add teeth to the AOP clause and also give the parties greater certainty as to their potential financial recovery or exposure for a violation.  

• The LDs that the owner is required to pay upon voluntary termination of the agreement could be reduced or waived if a competing hotel opens in the AOP. 

Companies understandably desire to continue to grow their portfolio of brand offerings. However, as this has occurred, many of today’s AOPs no longer meet the original intent of this provision, to protect owners from being negatively affected by new company hotels. This does not mean AOPs are obsolete; rather, the industry should explore ways to revisit AOP provisions to better protect the reasonable expectations of both parties. 

Story contributed by Lan Elliott, Acacia Hospitality, and Neva Wagner, Perkins Coie.