Development Agreements Aid Franchisees

Hotel & Motel Management:

agreements.jpgFranchising of multiple units offers positive and negative challenges to franchisors and franchisees.

The most common technique used in the hotel industry in the United States for multiple-unit franchises granted by a franchisor is through area development agreements.

The franchisor and franchisee enter into a development agreement that spells out where the franchisee can develop hotels.

Usually the territory is given as an exclusive provided the franchisee developer meets the development schedules set forth in the development agreement. For the project to be worthwhile, the territory should be large enough to provide for development of multiple hotels within the time period set forth in the agreement.

From the vantage point of the franchisor, the area developer franchisee should have the financial and managerial capability to develop multiple units itself. Development agreements with new hotel chains or new hotel concepts within an established chain are especially suited to promote rapid development of hotels through development agreements. This program attracts larger and more sophisticated investors that have sufficient capital to develop multiple hotels within a relatively short period of time.

The franchisee developer benefits from the economies of scale in developing multiple hotel units. Further impact issues normally are not present because the franchisee usually is granted exclusivity within its territory during the term of the development agreement. In addition, during the term of exclusivity the franchisee is afforded the opportunity to develop hotels in the best hotel sites in its territory.

If the franchisee fails to meet its development schedule, the exclusivity and development agreement is terminated, although in most instances the franchisee is permitted to retain the hotels it already has opened. The franchisee usually pays a substantial development fee at the time of the execution of the development agreement. As each hotel is opened, a portion of this fee is applied to the application fees for each hotel. In the event the development schedule is not met, the remainder of the development fee often is allocated to the franchisor as liquidated damages.

The hotel franchisor needs to exercise care to ensure it has selected an appropriate developer franchisee, and also that it has set forth a realistic development schedule.

Hotel franchisors also are concerned that affording a franchisee what amounts to a territorial monopoly may give the developer franchisee too much power. On the other side, in markets a hotel franchisor has had difficulty entering, area development agreements can prove mutually beneficial.

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