Liquidated Damages In Your Hotel Contracts

The information provided in this video does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. Information in this video may not constitute the most up-to-date legal or other information. Readers of this website should contact their attorney to obtain advice with respect to any particular legal matter.

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Check out what Barbara Dunn (Partner at Barnes & Thornburg LLP, representing groups) and Lisa Sommer Devlin (Devlin Law Firm, P.C. representing hotels) have to say in Legalease With the Ladies- powered by HopSkip!

Video Transcript:

Liquidated Damages

Lisa: Hi, I’m Lisa Sommer Devlin, an attorney that represents hotels and resorts regarding convention related matters.

Barbara: Hi, I'm Barbara Dunn, an attorney that represents groups in connection with their meetings travel and hospitality contracts.

Lisa: And together, we're Legalease with the Ladies powered by HopSkip. This video is going to be your tutorial on contract damages. We're going to focus on liquidated damages. But before we get there, it's important to understand that anytime you sign a contract whether or not it has a damage clause in it, if you breach that contract, you are legally obligated to pay damages. The law automatically steps in and provides that. So, if you ever have a contract that you sign that doesn't have a cancellation clause or doesn't have an attrition performance clause, don't assume that that means that you aren't going to be responsible. It means you're 100% responsible under that contract.

Now if you don't have that damage clause in your contract, what you're going to owe is actual damages. So, if you cancel an event at the hotel, the hotel would have to prove what the revenue was that it was going to generate from that event. What its expenses would have been and what profit it would have had? What money it actually would have put in the bank had the event happened. And that's a very complicated process in the hotel business. We could have a 45-minute video explaining why it's so difficult to figure out what the profit would be on any room or group of rooms. But just trust us when we tell you that it's very hard to really figure out the profit that a hotel would make on a particular event.

So, what is almost universally done in hotel contracts is they use what's called liquidated damage clauses. What the law says about liquidated damages is this. There are three elements. The parties agree that damages will occur if the contract is breached. They agree that the amount of damages would be difficult to determine. And then they agree on an amount that will be paid rather than having to prove actual loss. That's the typical liquidated damage clause in attrition performance or cancellation in every hotel contract you've ever seen. The parties are agreeing on a formula or a dollar amount that's going to be paid in the event that the group doesn't fill its block or cancels entirely.

So, that's really the basis. What the law says is that, you have to agree on an amount that's reasonable. It can't be more than what the hotel would have made had you actually had the event. It has to be a reasonable estimate. And the thing I see most in the event industry is that parties don't really negotiate those amounts. They tend to just stick in figures or percentages and they don't really figure out where they're getting those numbers. You should be really evaluating. If I cancel this meeting in January, how much is the hotel going to lose and how much opportunity are they going to have to resell that? And make up part of that loss and then come up with a fair number. That's what you should be doing in all your damage clauses. Whether it's for a catering event or anything else. It should be a fair estimate of the loss.

Now it's also important to understand that while many people think this, the law of liquidated damages, does not require proof of the hotel's actual loss and it does not require any credit for resale or mitigation. When you're negotiating those clauses, you're supposed to be factoring in the ability of the hotel to resell that cancelled or unused inventory. So, you don't add mitigation on top of that. I know many groups think that that's really important and they want that anyway. If you do, you have to have a very specific clause that defines how resale will be calculated and what credit will be given. If you don't, you are just going to buy yourself a dispute. Because there's a million different ways that you could calculate mitigation.

One final thought before I turn it over to Barbara for her analysis on this is that, you also don't have to have damages be based on profit. The word ‘Profit’ doesn't have to be included in the clause and you don't have to talk about profit at all. Yes, your damages should not be so high that they would exceed what the hotel would likely make. But you don't need to have the word profit. If you ever include the word profit in your damage clause, you have to define what that profit is. Whether it's 80% or 70% or whatever number it is you agree upon. And you don't have to call it profit. You can just say we will pay 70% of the room rate. Because it isn't really the profit because every room sold in a hotel has its own particular profit margin.

So, again remember the high points. You don't have to have proof of actual loss or mitigation and you don't have to have profit. If you agree on those things, it's critical that you have very specific formulas that outline how those calculations will be made. Barbara, how do you recommend these clauses be handled with your clients?

Barbara: Well, thank you Lisa. And laying out those elements as you did on liquidated damages, it really is something that brings to heart to groups and hotels the need to really decide what is a reasonable estimate of the damages. Specifically, penalties are not enforceable. And as you indicated Lisa, an amount that would give the hotel more than it would have received had it performed the meeting. Those aren't likely enforceable. Of course, just because you call it a penalty doesn't make it a penalty but it doesn't look good either. So, I recommend definitely staying away from the word penalty.

When I'm looking at contracts I kind of know the sophistication by which I’m looking at the draft or if I see the word penalty. Because I know no lawyer would put that word penalty in there because they would understand the concept. Nevertheless, as you point out Lisa it really doesn't matter what the damages are called. It's important though that you have that formula that you mentioned. And just as you mentioned whether it be attrition or cancellation, you have to define the elements of the formula and the basis on which you'll calculate those damages. I think that's particularly important. Because often some of those terms are left to chance.

For example, it might be the number of rooms that I didn't hit toward my target multiplied by the average group rate. And then you've got group rates at four or five different tiers and blocks of different tiers etc. You need to be as specific as you can when you're building that formula. So, that's an important aspect to it. In terms of cancellation, the concept of liquidated damage I think is particularly illustrative when we look at cancellation fee clauses  in hotel contracts. And just as you mentioned Lisa, the hotel factors in their ability to resell the rooms. So, the farther out the cancellation is made, the lower the damage is. The closer  to the meeting the cancellation is made, the higher the damage is.

So, those time frames those time parameters as you point out Lisa, just as though groups and hotels don't often negotiate particular damage amounts, they also often don't look at those time parameters. I’ve recommended to groups over the years that they really look at those time parameters and make sure it makes sense for the group. For example, if your go- or no-go decision date for a meeting is nine months out, make sure that 9-month window is at the lower cancellation fee tier before those damages kick up. And work to negotiate that, that's really an important element as well.

On the topic of resale, I agree with Lisa. Certainly, liquidated damages are essentially designed to be a pay it and walk away circumstance. However, the group and hotels certainly can negotiate an additional provision to add with regard to resale. But as Lisa points out, it's really important to be as specific as possible when it comes to resold rooms. Actually, my guidance to clients has been forget the resale go ahead and go back to the cancellation fee schedule and reduce the cancellation fee amounts. And essentially, take it off the top. Anticipate that amount that the hotel would resell and just take those as damages. That is one good workaround strategy that I’ve found.

Two more points. One, be careful. There are hotel contracts out there in which the cancellation fee schedule is mutual. So, those liquidated damages although you work so hard to do a reasonable estimate of the hotel's damages that the group cancels. That now applies going both ways. So, the hotel cancels on the group, the group has to accept that same amount as liquidated damages as a reasonable estimate. And at the end of the day, there's no way those two numbers could look alike. Because there's no way to estimate damages if a hotel were to cancel on a group 60 days out. Where would the group even go? What would its damages be etc.? So, I know your perspective Lisa over the years and mine have been. I don't like those clauses; I don't believe them to be enforceable. And my preference as to hotel cancellation is to instead specify that it's a grocery list of damages that would be involved if the hotel were to cancel on the group.

I think that's a better strategy. But I bring that up to say, if you go back to your cancellation fee clause and start lowering those numbers and it is a mutual cancellation fee, you've just taken money out of your own pocket. So, be very careful in negotiating those. One last comment is when groups and hotels agree to amend contracts to change the dates of the meeting or to reduce the room block, often those changes aren't translated into how it impacts the cancellation fee schedule or for that matter the attrition fee formula. So, what I’ve seen happen over the years is that if the dates change the parties don't go ahead and change the cancellation fee schedule. So, the dates and the cancellation fee schedule have nothing to do with the dates for the new meeting. And yet the hotel would say, ‘Hey, no those are enforceable anyway we want those dates.’ Or the room block has been adjusted, but the dollar amounts in the attrition or cancellation have not been adjusted.

So, it's very important. Again, we want an enforceable provision, we want a provision to be able to pay it and walk away. It has to be a reasonable estimate, so you really have to look at how that translates across all aspects of the contract that have the liquidated damage provision in there. And Lisa, I know you and I are aligned in that and we often have those come across our desk when the parties sometimes issue what they want to call an addendum to the contract. And make those changes and kind of reminding them that it's important to go through and make sure everything is synced up in the amendment.

Lisa: Absolutely, right Barbara. Barbara and I have had a lot of fun doing these videos for HopSkip, but this one I think is probably the most important of all the videos we've done. I hope that every time you negotiate a contract going forward you come back and listen to this video again. Because the information we're giving you here we're aligned on and it's very critical. Again, Barbara agrees with me. You don't have to have mitigation in a cancellation clause and it's better to negotiate a lower amount and simply be done than to add resale.

If you're canceling an event now for 2022, your boss is going to say, ‘Well, what's it going to cost us?’ You want a clause that you can say to your boss, it's going to cost you XYZ. Not a complicated formula just a damage clause that says, ‘If you cancel before June 30^th, you owe $50,000.’ Whatever it is, whatever amount you have agreed on. And then you can say to your boss, ‘It's gonna cost us $50,000.’ If you build in one of those complicated formulas for resale, you're going to have to say to your boss, ‘I don't know. We have to wait until 2022 to figure out what they resold. And we're going to have to figure out if we can reach agreement on what this resale clause means.’

It's a lot better from your perspective as the group and the hotel's perspective to have that agreed upon amount. I will tell you that my clients every day would much prefer to agree on a lower amount of liquidated damages with no resale than to have a resale clause added. The next thing that Barbara said that is really critical is, you don't want to have a mutual cancellation clause. Again, remember your liquidated damages are supposed to be a reasonable estimate of the loss. There is no way that the group suffers the same amount of loss as the hotel in the event of a cancellation.

From the group's perspective, the amount that they could lose could be much higher or much lower. It's not as easy to try and estimate as it is on the other side. So, Barbara and I again agree that a mutual cancellation clause is probably not legally enforceable and not a good idea from the group perspective. Any last thoughts Barbara?

Barbara: No Lisa just to say that I echo your comments that, this is an important element. And it is one in which we would always recommend, have your legal eagle, weigh in on the clause. Because making changes here there for the reasons we've illustrated can really make a difference.

Lisa: Thanks for joining us for this video. This has been Legalease with the Ladies powered by HopSkip. Please leave your comments below and we look forward to see you in the next video.

The information provided in this video does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. Information in this video may not constitute the most up-to-date legal or other information. Readers of this website should contact their attorney to obtain advice with respect to any particular legal matter.