With the booming hospitality sector in Saudi Arabia and the tremendous transformation driven by Vision 2030—aimed at attracting millions of visitors from around the world through various entertainment and sporting events hosted by the Kingdom—the demand for hotels has increased significantly. As a result, the Kingdom has adopted the hotel management agreement model to enhance hotel operations and, consequently, improve the overall guest experience.

So, what exactly are hotel management agreements? And what are the essential features of these agreements? This is what we will explore in this article.

What are Hotel Management Agreements?

The hotel sector in Saudi Arabia is undergoing a major transformation. With the growing demand for hotels, the need for a legal framework to govern the relationship between commercial property owners and hotel operators has become increasingly important. Many people are unaware that any hotel essentially consists of two companies: the company that owns the property and the management company that owns the brand.

Recognizing this, Saudi Arabia began adopting the hotel management agreement model to regulate the relationship between these two entities responsible for hotel operations—particularly with the surge of visitors drawn by the Kingdom’s expanding entertainment scene. Hotel management agreements have emerged as a practical solution for managing the industry and as an attractive opportunity for investors seeking partnerships with leading hotel brands.

These agreements can take several legal forms, the most prominent of which are:

First: Franchising and Licensing

We are dealing here with two different models. The first involves hotel operators that own and manage their properties, meaning that management, ownership rights, and reservation systems are all handled internally. In this model, franchises and licenses are not part of the organizational structure.

The second model involves hotel operators who license the brand from a third party. A franchise or licensing agreement may be in place. In this case, the property owner must ensure that the operator has conducted proper due diligence regarding these arrangements and that the agreements remain valid for the entire duration of the contract.

The agreement should also include representations and warranties regarding the adequacy and status of the franchise or licensing agreement, as well as covenants to maintain it in force, and intervention or remedy rights for the benefit of the commercial property owner to ensure continuity and compliance.

It should be noted that these franchise or licensing agreements cannot be used to define the specific terms and conditions of the arrangement between the commercial property owner and the hotel operator; however, they form an important part of the overall context within which the hotel management agreement is properly concluded.

Secondly: Lease Agreements

Lease agreements are fundamental to income-generating assets in the commercial real estate sector. They are legally binding contracts that guarantee the rights of both the property owner and the hotel operator. From the tenant’s perspective, lease agreements ensure a registrable right to the land, protect against third-party interference, and limit the owner’s ability to disrupt the tenant’s business operations.

From the owner’s perspective, lease agreements establish a clear and defined obligation to pay rent, specify responsibilities and obligations at the end of the contract term, and grant certain privileges in the event of the tenant’s bankruptcy.

Despite these advantages,  this model is not preferred for use in hotel management. . The reason is that fixed rent poses a significant risk to the operator in the event of a market downturn and does not accurately reflect the hotel’s operating profits. Moreover, traditional lease concepts are not compatible with the nature of the hotel business, which relies on variable operations and fluctuating income.

As a result, the relationship between the owner and the operator has evolved into a form of agreement that combines the benefits of a lease while eliminating its drawbacks, incorporating special provisions tailored to the nature of hotel operations. This is what is known today as a hotel management agreement.

Third: Hotel Management Agreements

The third legal framework governing the relationship between the commercial property owner and the hotel operator is the hotel management agreement. This represents a more advanced and modern form of hotel lease agreements and is known by several names, most notably operating service agreements and hotel operating agreements.

Hotel management agreements have their own specific standards and regulations, aiming to establish a deeper business relationship between the owner and the operator. They grant the property owner a voice in strategic decisions and allow them to benefit from the potential profits generated by the hotel’s performance.

Fourth: Revenues, Expenses, and Fees

The section concerning revenue sharing is the most important part of a hotel management agreement. Unlike lease agreements, where revenue is fixed through a predetermined rent, the owner in this case receives all net revenue after deducting costs and operator fees. This arrangement incentivizes the owner to control costs and ensures transparency in fee calculations.

Regarding fees, the common market practices dictate how profits are distributed. current market practice involves setting both a base fee and an incentive fee for the hotel operator. As for budgeting, this structure provides the property owner with a mechanism to approve the budget, serving as a control tool to monitor performance and manage expenses effectively.

Fifth: Management and Employees

It has become common practice for hotel management agreements to require that all employees working in the hotel be legally employed by the commercial property owner.For many owners, employing staff to serve tenants is an uncommon practice; therefore, owners should pay particular attention to this requirement and ensure its legality.

Although the hotel manager usually supervises the employees directly, their status as employees of the owner complicates the legal relationship between the parties. In exchange for assuming employment responsibilities—or due to their involvement in operational activities—the owner may obtain the right to approve or reject appointments to key management positions.

When drafting these rights, consideration should be given to the operator’s organizational structure, the status of existing employees, and the need to ensure their job security. Owners should also carefully assess the actual authority these rights grant them.

Sixth: Renovation and Development

The legal framework of hotel management agreements includes a Property Improvement Plan (PIP)—a structured plan outlining the necessary upgrades and renovations that the commercial property owner must undertake to maintain brand standards. The obligations under the Property Improvement Plan typically extend throughout the duration of the hotel management agreement and and it shall be updated periodically at intervals mutually agreed upon.

To ensure that commercial property owners adequately fund these obligations, hotel management agreements often require the establishment of a reserve account, funded by a fixed percentage of gross revenues. This mechanism guarantees adherence to the plan and ensures the periodic renovation and upkeep of the hotel.

Seventh: Term and Termination Rights

Hotel management agreements generally have fixed terms that are longer than typical commercial leases, sometimes extending up to 20 years. They also include termination rights for each party in the event of a breach of obligations by the other. However, because longer terms tend to disproportionately benefit hotel operators, it is common for property owners to negotiate additional termination rights.

Property owners may also secure termination rights in the following circumstances:
(a) Upon the sale of the property.
(b) Without cause after specified periods (to allow for property redevelopment or other reasons).
(c) If projected revenue targets are not consistently met. This last right can replace—or operate alongside—a minimum revenue target clause to ensure that hotel operators do not overestimate gross revenue.

Conclusion

Hotel management agreements form the cornerstone of the relationship between commercial property owners and hotel operators, surpassing traditional lease models due to their flexibility and adaptability to the sector’s needs. This makes them an ideal framework for fostering collaboration and creating long-term value in the hospitality industry.

If you are looking for professional assistance in drafting and structuring these agreements, you are in the right place. At Mohammed Al-Khliwi Law Firm, we will help you complete all necessary procedures with expertise and ease.

Disclaimer: This content is not legal advice. No liability is assumed. For legal consultation, please contact us.