Several years ago, I represented an association that was being sued by its headquarters hotel, a major convention property in a first-tier city, for performance damages exceeding approximately $130,000. The case - ultimately settled with the association paying a large sum to the hotel - serves as a good example of what can happen when a group shoulders all the risk should the economy take a tumble before its meeting. Let's take a look back at the surrounding facts and the terms to which the association had agreed in its contract.

The association's meeting had been booked several years prior to Sept. 11, when the economy and attendance at annual meetings were robust. The group's room block at the hotel was approximately 4,000 room nights with a single/double rate of $250. The hotel contract required the group to guarantee a minimum of $800,000 in room revenue at its event after 20 percent allowable attrition. After Sept. 11, the economy took a substantial downturn, as did attendance at association meetings … and, from 2002-2005, average rates at hotels.

The association's annual meeting took place during this time period. In the months preceding the association's event, the highest rate at the headquarters hotel dropped to $180 due to the economy. The association's attendees booked approximately 3,440 room nights, i.e., 86 percent of its room block at the hotel. How many attendees do you think made a reservation at the $250 rate? Less than 20 percent. The rest made their reservations at rates of $180 or less because the hotel offered those lower rates. The result: The association picked up more than 80 percent of its room nights, but was more than $130,000 short in reaching its minimum revenue guarantee. In essence, the association was paying a high price because it had booked its annual meeting several years in advance without predicting the events leading to a slowdown in the economy at the time of the meeting. Perhaps the association could have avoided this financial disaster by using a different method of compensating the hotel for falling below a minimum guarantee.

Contract law provides that if one side breaches a contract through underperformance or nonperformance, the other side is entitled to damages. The purpose of this rule is to put the injured party in the same financial position as if the contract had been performed (or, in some cases, as if the sale had never taken place). This is called giving the injured party the "benefit of the bargain." Because potentially large sums of money are at stake, the parties must strategically decide how to prepare a provision for damages that best accomplishes this goal, meets a reasonableness standard, and is acceptable to both the association and the hotel.

It is routine today for hotel group contracts to have performance guarantees; however, hotels and associations have a choice on how performance guarantees for guest rooms are stated and measured in the contract. The preferred method is to provide for liquidated damages. [This article addresses only attrition damages based on guest-room sales. Damages for attrition in catered food and beverage functions are not discussed.] To be enforceable, a liquidated damage clause in a hotel contract must have some rational relationship to potential actual damages and must not be a penalty to the association. A penalty exists if the liquidated damage provision is calculated to penalize the breaching party and put the other party further ahead financially if the contract is breached than if the contract had been performed as written. If a liquidated damage clause is held to be a penalty, a court will not enforce it and the injured party must prove its actual damages.

There are two general types of liquidated damage provisions used in hotel contracts to compensate hotels if a group underperforms by attrition (or has total nonperformance by canceling). The two general types are: 1) a minimum guest-room revenue guarantee, versus 2) a minimum room-night guarantee by the association. There are different ways to apply these methods, including stating a simple formula, using a sliding scale, or implementing a combination of the two.

Let's look at which method associations prefer and which method hotels prefer.

Minimum Guest-Room Revenue Guarantee Method
This is the one hotels favor. The typical minimum guest-room revenue guarantee clause in hotel contracts requires the group to guarantee a minimum dollar amount, as was the case with the association I represented. A revenue guarantee gives the hotel certainty over the revenue it will receive, enabling the hotel to forecast future performance with accuracy to owners and lenders. The minimum amount is usually a product of the group rate, the number of rooms held by the hotel, and the percentage of allowable attrition. If the group falls below this amount, the hotel charges it for the difference, usually in gross revenue.

Associations that agree to guarantee a minimum amount of guest-room revenue don't always understand the risks they are accepting. By guaranteeing minimum guest-room revenue, the meeting sponsor is accepting all of the risk if the economy falls after the contract is signed but before the meeting takes place. When this happens, hotels adjust all of their rates downward to be competitive - except the higher rates that apply to groups. When all of the rates in the hotel except the group's rate are adjusted downward, the meeting sponsor has little chance that its attendees will pay the higher negotiated group rate, enabling the association to meet its performance guarantee. This is what happened with the association I represented.

Hotels make it relatively easy for attendees to get a discount rate on the Internet (their rooms are regularly sold on Priceline.com, Bestfares.com, Hotels.com, and Hotelson line.com, and with hotel consolidators and companies that use the hotel's chain in high volume). Even if the economy stays the same as when - or improves after - the contract is signed, associations guaranteeing guest-room revenue accept all the risk of their attendees going around the block to book a room at a lesser rate offered by the hotel. Obviously, association planners have no control over the rates offered by their contracted hotel; rate control is the sole purview of hotel revenue managers. Its potentially negative consequence is totally shifted to associations because they book meetings far in advance. It is hard enough for a planner to predict attendance for a meeting a few years away - much less to predict the economy and market rates, too.

Convention hotels are pleased to offer reduced rates to get heads in beds if a group has guaranteed a minimum amount of guest-room revenue. If the hotel's revenue goes below forecast for the group, the association becomes the hotel's guarantor and is responsible for making up the difference. The example I provided is a case in point. Since it is foreseeable that the economy will go up and down, the issue is whether an association should take all the risk when the economy falls and its contracted hotel lowers its rates. Most associations believe that this is a risk they should not be required to take because they cannot budget for it without substantially raising the price of registration for meetings. Raising registration fees in a slowing economy would have a negative effect on attendance at meetings and conventions. This is an outcome that would not benefit associations … or hotels.

Minimum Room-Night Guarantee Method
Associations should negotiate their performance clause for calculating attrition, if any, based on a minimum room-night guarantee versus a minimum guest-room revenue guarantee. Guaranteeing minimum room nights is the traditional way hotels tracked group performance and performance damages in contracts for years. Using this method, an association guarantees to use or pay for a minimum number of room nights that it asks the hotel to hold, less a percentage of allowable attrition, i.e., 20 percent to 25 percent.

To offer a reasonable approximation of actual damages, this clause should also credit rooms resold by the hotel to offset the association's potential damages. The association still bears the risk of low pick-up, and the hotel is still compensated for unsold rooms. The association pays for the number of guest rooms below the minimum, if any, at the negotiated group rate (usually the lowest single rate). The parties should agree on, and state in the contract, a percentage by which to multiply the resulting revenue number to determine the hotel's estimated lost profit. The industry average profit margin in guest rooms is between 70 percent and 80 percent (some hotels may be higher, others lower).

There are several basic issues that should be covered in any performance clause based on the minimum room-night guarantee method. For instance, when calculating the number of unsold rooms, do you use the number of rooms "occupied" or the number "sold"? What is included in the definition of "sold rooms"? How are damages defined, i.e., gross revenue or estimated lost profit? (See the sidebar on p. 158 for a sample formula for tracking attrition; see the sidebar at left for a sample attrition calculation.)

Self-Preservation And Risk
Every hotel group contract has risks associated with the association being held responsible for a minimum performance level. This comes with the territory when planning meetings where attendance is optional and attendees pay their own expenses. It is important that an association educates its potential attendees about the financial risk their association assumes when forecasting attendance and room blocks. That being said, associations should always assume that attendees will make decisions on where to stay and what rate to pay based on what benefits them, not necessarily the association.

Since most attendees think about self-preservation first, associations must think strategically about how much and what kind of risk they should assume in their hotel contracts. Associations also have to consider that the risks must be balanced with those of the hotel, and that hotels, of course, have a say on how they will be compensated if and when an association either picks up fewer rooms than expected or cancels the total use of the hotel. The formula and example attrition calculation offered in this article are intended to be fair to both sides.

Formula for Guest-Room Attrition Based on a Minimum Room-Night Guarantee

• Start with total rooms in the hotel's inventory each night.
• Subtract "off-market" rooms from hotel's inventory each night. (Off-market rooms include rooms being repaired or renovated, and also include suite parlors and sell-last rooms held for last sale to members of hotel's preferred guest programs that go unused.)
• Minus "sold" rooms. ("Sold" rooms include rooms occupied and paid for in-house as well as rooms billed to other groups or individuals for attrition, cancellation, or no-show.)
• = Total unsold rooms in hotel each night.
• Take final room block per night.
• Minus allowable attrition each night. This results in an adjusted room block. (Allowable attrition is usually 20 percent to 25 percent per night.)
• Minus rooms occupied / paid for each night by group attendees.
• = Total group shortfall or overage per night. (Any night when the group's actual group pick-up exceeds the adjusted room block for that night - producing a negative number - the excess number of room nights each night will be called "overage rooms." Overage rooms will carry over to subsequent nights as a credit to offset any nights where there is a "shortfall" - producing a positive number - if any. A shortfall occurs when pick-up is below the adjusted room block each night on one or more nights.)
• Compare the unsold rooms in hotel each night to the group's shortfall or overage each night.
• The group's maximum liability is for the lesser of the above numbers each night. Each night's total is then added to determine a cumulative number of attrition room nights.
• Minus credit for rooms booked around the block.
• Minus credit for earned but unused comp rooms.
• Minus credit for room nights from early arrivals/stayovers.
• Minus credit for comp rooms earned on attrition room nights.
• = Total attrition room nights.
• Multiply attrition room nights by lowest single rate.
• Multiply resulting revenue by an agreed-upon percent to represent the hotel's estimated lost profit. (Industry average is 70 percent to 80 percent.)
• = Total amount due for attrition damages from guest room

©2008 John S. Foster, Esq., CHME, Atlanta. All rights reserved, John.Foster@FJGLaw.net. John S. Foster, Esq., CHME, is an attorney and counsel whose firm, Foster, Jensen and Gulley, LLC, specializes in the legal aspects of meetings and conventions, trade shows and events, and association management. He is an associate counsel for 400-plus national and regional associations and companies. PCMA named him Convene Author of the Year in 2003. The legal columnist for Convene, he is the author of Meeting & Facility Contracts, Meetings & Liability, Independent Meeting Planners & the Law, and What Every Hotelier Must know about Legal Affairs Management.