The International Hotel Law Review: Mexico
The hotel sector in Mexico faced two major regulatory challenges in 2021: an amendment to the Federal Labour Law (FLL) and related tax provisions banning outsourcing (Outsourcing Reform); and the publication of a new project of the Mexican Official Standards (NOM) on timeshare services (Timeshare NOM Project).
The Outsourcing Reform has required several companies – including those not participating in the tourism sector – to modify their employment structures, since typically hotel companies incorporate specific entities for hiring employees, comply with labour and social security obligations, make these expenses tax-deductible and somehow limit the amount to be paid as mandatory profit sharing. Once the Outsourcing Reform came into full force and effect as of September of this year, such structures could be deemed as intended to avoid taxes and social security quotas (among other obligations), thereby giving rise to criminal liability for tax evasion, money laundering and organised crime, depending on aggravating circumstances. This topic is discussed in more detail in Section X.
With regard to the Timeshare NOM Project, although it has not yet been published as a final and controlling guideline on the minimum requirements that a timeshare agreement must have, dialogue between the Federal Consumer Protection Agency and market agents has evidenced a certain reluctance on the part of the latter to address an array of concerns from hotel and hospitality chains as well as national and regional timeshare agents' associations. In the event the Timeshare NOM Project is published as proposed in the final version provided after the dialogue with the hospitality sector, the main issues would be the following:
- a five business day cancellation period following the execution of a timeshare services agreement; additionally, in the event the cancellation is sent by registered mail, the date on which the client sends the cancellation notice through the courier service shall be deemed as the date of cancellation;
- the timeshare service provider's sole and exclusive liability for covering the maintenance of the property where the services are rendered in the event that the ordinary and extraordinary maintenance fees are insufficient for such purposes, unless the deficiency arises from the users' default in the payment of such fees;
- clients' ability to participate in the decision-making process of the modification of common areas; and
- during the promotion, sale and execution of timeshare agreements, the timeshare service provider shall adopt all necessary measures to avoid offering alcoholic beverages during the promotion, sale or execution of timeshare agreements.
Notwithstanding the foregoing, there are certain market entry restrictions that shall be considered prior to addressing the challenges indicated above. Such market entry restrictions are addressed in the following section.
Finally, a 2021 fiscal reform aimed at taxing digital platforms has impacted providers and communities in the hospitality and leisure industries.
Article 27 of the Mexican Constitution is the cornerstone of Mexican real estate and outlines real property rights. This chapter sets forth certain restrictions on foreign individuals or entities from holding direct title over lands located on a strip of land of 100 kilometres (i.e., approximately 62 miles) from the Mexican borders and (approximately 31 miles) on the beach front (the restricted zone). This provision defers to the regulatory statutes to outline modalities and the limitations under which foreign nationals can acquire use and enjoyment rights or indirect ownership through the creation of a Mexican vehicle – either a company or through a trust agreement – as described below.
The Foreign Investment Law (FIL) and its Regulations (FIL Regulations) classify foreign investment as direct when it is undertaken by a foreign national (individual, entity or vehicle) directly and upon evidencing the due creation, legal existence and capacity of such foreign national for acting in Mexico, and as indirect when the foreign national creates a Mexican entity or vehicle for undertaking the investment.
For acquiring the use and enjoyment or ownership over real property that is destined for residential activities, the foreign national must incorporate a Mexican company or a trust agreement (i.e., indirect foreign investment) and obtain prior authorisation from the Ministry of Foreign Affairs (MFA) if the real property is located in the restricted zone. If the real property is located in the restricted zone but is not destined for residential activities, it can be carried out as direct foreign investment by providing notice to the MFA. Irrespective of whether the real property is destined for residential or non-residential activities, if it is located outside the restricted zone, then only a notice shall be given to the MFA.
Whether real property is destined for residential activities is determined pursuant to the FIL Regulations, which expressly classify timeshare as a non-residential activity. Additionally, hotel companies fall under the scope of non-residential activities, since the nature of hotels' business operations is tourism-related and not residential, and tourism-related activities are indirectly considered as non-residential under the legal framework indicated above. Due to the foregoing, both timeshare and hotel companies could acquire directly real properties located in the restricted zone with the sole obligation to give notice to the MFA within the next 60 business days following the acquisition.
Notwithstanding the foregoing, some hotel and timeshare companies prefer to acquire real properties located in the restricted zone through the second alternative for acquisition: a trust. As noted above, for the delivery of such trust agreement an 'Article 27 permit' issued by the MFA must be obtained. Although timeshare and hotel companies are not required to acquire real properties through a trust, there are certain business reasons for which trusts are considered convenient vehicles. This topic is addressed in Section III.
Pursuant to the civil codes of each state in Mexico, a conveyance of real property shall be formalised through a public deed granted by a notary public.2 Additionally, such deed shall be registered before the local Public Registry of Property to have effects on third parties; nevertheless, in the state of Quintanta Roo (where most of the Riviera Maya is located, such as Cancun and Tulum), such registration is mandatory to complete the transfer of the property.
The legal structures most commonly used for acquiring the ownership of a property in the hotel and timeshare sectors are direct acquisitions and trusts as special purpose vehicles (i.e., indirect foreign investment). Note that, in Mexico, only Mexican banks (and another few entities of the Mexican financial sector) are authorised to act as trustees, which entails compliance with several tax and money laundering prevention regulations. Specifically, regarding timeshare companies, trusts can be a useful vehicle to set forth the main rights and obligations of a homeowner association (HOA) as well as its interaction with other entities involved in the operation of a hotel, for example, the right of an HOA to hold title over the real property where the hotel is located once the trust term expires. It shall be considered that generally, trust agreements cannot exceed a term of 50 years; nevertheless, such term can be extended for a similar period of 50 years or less once the initial term concludes, provided that the trust holding title over real property located in the restricted zone applies for a new permit from the MFA.
The typical business ownership structure is to incorporate a limited liability company (LLC) or a company (sociedad anónima), for which at least two partners or shareholders – either national or foreign – are required.3 The LLC has been a preferred choice for investors whose country of origin consider them as pass-through or tax-transparent entities for tax purposes (such is the case for the US). Additionally, some companies incorporate two or more entities to divide its operations between:
- the entity managing the hotel;
- the entity holding title over the real property;
- the entity developing the hotel during the construction process; and
- the entity under which the employees are hired, which, as described in Section X, is now heavily restricted and screened.
Furthermore, the construction of hotels is particularly affected by the urban development plans issued by the municipalities; and the local, state or regional environmental management units. These regulations may restrict the type of materials used in the construction or even totally restrict construction over certain specific portions of land where some relevant environmental areas are located, such as mangroves. Additionally, urban development plans mainly restrict the land use, as well as maximum construction and occupation areas through the ratios set forth therein: for example, a ratio of 0.8 for the maximum construction area and a ratio of 0.4 for the maximum occupation area on a land area of 10,000 square metres would allow building up to 8,000 square metres, provided that on the first floor no more than 4,000 square metres are occupied.
On the other hand, the Federal Maritime Terrestrial Zone (ZOFEMAT) – a 20 metre strip of firm land from the shore determined by the Ministry of Environment and Natural Resources – is a key element to consider for beach front hotels. In Mexico, no private parties are able to hold title over the ZOFEMAT as it is considered national property. However, a concession for the exclusive use of such area may be granted the Ministry of Environment and Natural Resources.
Additionally, as the foregoing framework is federal, regulations on civil protection programmes, health and hygiene for food and beverages, and state and municipal licences shall apply. Specifically for timeshare companies, agents selling timeshares in certain states – for example, Baja California Sur, where Los Cabos is located – are required to obtain certain real property broker licences.
Lease agreements have been traditionally used together with hotel management agreements, albeit use of the latter has increased with international tax structures that involve franchise agreements (as discussed below). Lease agreements are governed by the Civil Code of the state in which the property is located. As a general rule, the duration of leases is limited to 20 years or, in some isolated cases, 40 (in Nuevo León). Some states allow the maximum duration only for commercial or industrial purposes. By the same token, lease agreements with a term longer than six years or those in which rents are received in advance for more than three years must be recorded with the Public Registry of Property of the state where the real property is located.
Additionally, leases in which the rent surpasses certain thresholds (around US$10,800) must be informed by the parties thereto as a vulnerable activity with a type of know your customer report to the Financial Intelligence Unit, the anti-money laundering arm of the Ministry of Finance and Public Credit.
Intellectual property and branding
Tailored intellectual property (IP) protection and counselling is needed for a successful transaction, particularly in the hotel sector. The creation of a distinctive and unique identity is paramount to identify a brand with customers, protect the business and prevent imitators and free riders alike.
During a major transaction, the purchaser needs to ensure that all the IP of the seller is transferred properly, which is usually carried out through:
- trademark assignment agreements, which need to be registered with the Mexican Institute of Industrial Property;
- copyright agreements used for the transmission, modification or encumbrance of economic rights pertaining to an author, which need to be registered with the Copyright National Institute in connection with manuals; or
- in some cases, licence agreements over the seller's IP, such as trademarks, economic rights of authors and other intellectual property that the seller intends to retain after a transaction is carried out or when the transaction does not involve a total acquisition.
Such agreements also need to be recorded with both agencies and are used to exploit third-party IP rights under certain conditions in exchange for royalties.
Presumably, the two main issues of acquiring the IP of another hotel company are:
- the implementation of a rebranding strategy that is often required by customers who wish to create a different identity with the recently acquired IP; and
- the safeguarding of information that allows any company to compete efficiently, such as trade secrets, research data, pricing systems and formularies.
These issues could be addressed through:
- the registration before the corresponding authorities of the acquired IP and, at the same time, the implementation of a marketing and promotional strategy involving social media, the purchase of web domains and the diffusion of the transaction to the public; and
- the implementation of mechanisms such as firewalls and passwords, and the execution of non-disclosure agreements and non-compete agreements and policies that will have to be strictly followed by the purchaser's personnel so that the relevant information is correctly safeguarded.
Data and hotel tech
Key issues regarding ownership and management of personal data revolve around three main items: declaration of consent to privacy notices; transference of personal information; and access, rectification, cancellation and opposition rights of individuals (ARCO rights). For the latter, the Federal Law on Personal Data Protection Possessed by Private Parties (Data Privacy Legislation) sets forth the minimum requirements for each of these items.
Private parties collecting personal information must have a privacy notice indicating the purpose of and the treatment to be given to the personal information that they collect. Moreover, when individuals submit their personal information (such as contact, financial and tax information) they must declare their acceptance for their information to be collected through any means. In the case of personal sensitive information (such as health conditions, ethnicity, religious beliefs and financial capacity) is collected, individuals must declare their acceptance and sign – either in wet ink or electronically – the relevant privacy notice.
The mechanism to transfer personal information or personal sensitive information must be explained to individuals in a privacy notice, and specifically the parties that might receive such data, where it is located, and how it is going to be treated and handled. As mentioned above, individuals must declare their acceptance of the latter.
Private parties that collect personal information from individuals must guarantee the exercise of ARCO rights. Such parties must establish through the privacy notice the mechanism for such rights, as well as the terms and conditions for an individual to execute those rights. It is important to mention that private parties that repeatedly deny the exercise of such rights without due reason are subject to a fine of approximately US$1.5 million in accordance with the Data Privacy Legislation.
In matters of e-commerce, the Federal Consumers Protection Law obliges service providers to guide themselves in the disposition of certain standards of e-commerce with provisions on, among others, mechanisms to verify transactions prior to their confirmation, mechanisms to document transactions, mechanisms on the security of transactions and mechanisms to file claims. Regarding online contracting, the Code of Commerce and the Federal Consumers Protection Law deem that the means of contracting do not modify or impact the juridical nature of contracts. Nevertheless, such contracts must contain specific elements, different from traditional elements, to be considered valid in connection with electronic signatures aimed to confirm that the parties have effectively agreed on the content of certain documents and to identify the parties signing such document.
In marketing matters, the Federal Consumers Protection Law establishes the same requirements for online publicity and traditional publicity, which mainly are intended to avoid any confusion or misleading of consumers. Nonetheless, in cases of online publicity, such Law establishes an opt-out mechanism for individuals to deny the use of their personal information in marketing matters, as well as to deny the use of their information for publicity subscriptions.
Franchising of hotels
Franchising of hotels is regulated by the Industrial Property Protection Federal Law (IP Law), which establishes all the requirements and specifications that franchise agreements shall include, such as:
- the geographic area in which the franchising activities will be carried out;
- inventory, marketing and advertising policies;
- financial policies;
- technical and operational characteristics with which the establishment must comply;
- terms and conditions for sub franchising; and
- performance policies.
According with the above, the Law defines franchise agreements as a trademark licence agreement, issued in writing, with the purpose of transferring the know-how of the products or services of a company, or both, or providing technical assistance, in order to enable the person to whom it is granted, known as the franchisee, to produce or sell goods or provide services in a uniform manner and in accordance with the operational, commercial and administrative methods established by the owner of the trademark.
In the hospitality industry, it is vital that the franchisee complies with the responsibility of maintaining the quality, prestige and image of the hotel, since any breach might affect the perception that the guests have of the business.
The IP Law does not provide any specific regulations related to the franchising of hotels, but it is relevant to understand that the franchisor has the right to intervene in the organisation and operation of the franchisee since the image and standards of management need to be observed and complied with.
Hotel management agreements
In Mexico, there is no specific law or standard on hotel management agreements (HMAs), although HMAs are typically used by major hotel companies both as inter-company agreements and as 'white label' agreements with third parties. Nevertheless, HMAs could partially fall within the scope of the IP Law when franchise provisions are included in such agreement.
As a general introduction, in Mexico HMAs follow typical agreement structures employed by international hospitality companies. In this regard, an HMA, understood as the agreement entered into by the hotel owner (the party holding title over the land and constructions where certain hotel facilities are located) and the hotel operator (the party managing the business operations of the hotel), sets forth two fees as consideration: a base fee that enables the hotel owner to receive a percentage of the gross revenue of hotel operators; and an incentive fee over the profit arising out of the hotel operations.
International practice on hiring employees under HMAs is to require the hotel owner to hire employees that are not considered as top management, although the hotel operator may participate in the selection of such employees. Nevertheless, the new Outsourcing Reform provisions also require modification of the labour structures under HMAs. This is addressed under Section X.
Additionally, clauses regarding obligations in connection with compliance with the anti-money laundering and tax provisions shall be always included in HMAs. The Domain Extinction National Law enables Mexico authorities to forfeit rights held by an individual or entity over personal or real property without paying any consideration, and therefore the inclusion of these provisions enables hotel operators to collect liquidated damages in the event of any domain extinction process.
Due to the effects of the covid-19 pandemic, force majeure, acts of God and early termination provisions have demanded heavy review and often renegotiation, and all the more so in the absence of business interruption insurance in Mexico.
Hotel loans may be structured in different manners depending on the size of the project or the amount of the loan. The following are the types of financing used in the hospitality industry:
i Mezzanine financing
Mezzanine financing combines equity and debt. The lender grants both equity and interest loans in exchange for equity in the company. When compared to other instruments, this is more flexible.
Not only does it offer more return than typical financial institutions, but it can also expand cash flow to be used for future expansion. However, bear in mind that, although it is easier to apply for mezzanine financing, it comes with higher interest rates.
ii Standard hotel loans
A standard hotel loan has a fixed interest rate and loan term often used for work capital, purchasing equipment and renovations. Once the lender grants the money, it needs to be repaid in the timely manner agreed upon. Payments will cover principal and accrued interests.
iii Permanent loans
These are intended for developers planning to build a new hotel being secured with a mortgage over the land. It is aimed to purchase the land and finance construction works; once the hotel is complete, the loan will be secured with a mortgage over land and constructions thereto. Additionally, a pledge over the furniture, fixtures and equipment (FF&E) may be required by the lender.
Loan agreements establish certain rights in favour of the lender in order to secure its investment, such as:
- approval by the lender for expenses over a certain amount, a lease of property or the granting of any security interest over the property;
- in the case of breach of the loan and operational documents, the right to terminate the loan demanding full return of the loan plus interests, liquidated damages or specific performance; and
- including in the agreement situations and manners in which the lender may intervene and decide on the operations of the hotel.
Non-disturbance agreements are rarely used in Mexico; such covenants used in private agreements are established in local legislation within the Mexican territory.
For all industries in Mexico, including the hotel sector, employment relationships are ruled under a constitutional principle of employment stability, which means that as a rule all employment relationships are deemed permanent, and there are only few exceptions in which the FLL allows a temporary employment.
All employees in Mexico are entitled to the following minimum benefits package:
- paid holiday of at least six days per year, increasing by two days per year until the fourth year of employment; after that, the annual holiday period increases two days per each five years of services;
- a holiday premium equivalent to 25 per cent of the salaries paid during paid holidays;
- a year-end bonus of at least 15 days of salary; this bonus must be paid every year before 20 December; and
- double or triple overtime depending on the extra hours worked during certain weeks.
As discussed in Section III, a common practice in the hotel sector was having the following structure from a labour standpoint:
- operating company: operates the hotel and receives all the revenue.
- services company: from the same corporate group as the operating company. Permanent personnel in a hotel were hired under this entity. This company usually charged the payroll cost to the operating company.
- outsourcing companies: third-party companies who assigned temporary personnel directly to work for a hotel.
Normally, sales personnel are not retained as employees, but as professional services providers, and would only be paid when a commission is generated.
This hiring structure was modified due to the Outsourcing Reform enacted on 23 April 23 2021, banning outsourcing, and only allowing it for specialised services that are not part of the corporate purpose or core business of the beneficiary of the services. Since the enactment of the Outsourcing Reform, most hotel companies have restructured their employment models, transferring the staff related to the operating company and outsourcing those activities that are considered specialised services (for example, security and cleaning services).
An employee can be terminated whenever there is misconduct classified as a justified cause for termination, in which case the employer would not have to pay severance; however, in the event the employee challenges the cause for termination and judge rules in favour of the employee, or if an employee is terminated without a justified cause, the employer must pay:
- constitutional indemnity of 90 days of total compensation (daily wage plus the daily portion of any other benefit granted to the employee);
- severance of 20 days of the total per year of services;
- a seniority premium equal to 12 days of salary per year (capped by twice the daily minimum wage in Mexico);
- a year-end bonus;
- unused paid holidays;
- a holiday premium; and
- payment of any other accrued benefits.
The payments indicated above shall be prorated for that year in which the employee has not fully completed the term.
In the event of litigation, if the employer fails to prove just cause for termination, the employee will be entitled to receive back wages for one year after the day of the dismissal.
Dispute resolution and management
Performance testing in Mexico is similar to international practice based on a two-prong test: the achievement of certain percentages (usually between 80 and 90 per cent) of the gross operating profit (GOP) indicated in the business or operations plan; and the achievement of an annualised revenue per available room (RevPAR) that is at least 80 per cent of the average annualised RevPAR of a set of hotels with locations, markets and prices similar to the hotel to be managed. Nevertheless, the RevPAR test may find some difficulties in being executed due to the financial information available. Additionally, although it is seldom required or agreed, hotel owners could ask for a test based upon the return of the funds invested by the hotel owners.
To avoid termination of an HMA, a right to cure – similar to that employed in international practice – can be used. Specifically, the right to cure may enable the hotel manager to pay the hotel owner for covering the difference between the GOP and RevPAR amounts effectively collected and the minimum amount indicated in the business or operations plan for one particular year of the tested period (usually two consecutive years).
The only specific exception for the termination of an HMA is force majeure events. Notwithstanding, the parties may agree to limit the scope of force majeure in order to restrict its application to certain events or even to completely eliminate it, although the latter is not usual practice, and more so when insurance for business interruption has not become fully operative and available in Mexico. Additionally, other termination causes such as the failure of the owner to make the agreed expenses on FF&E also apply.
Although in the US there has been an ongoing discussion regarding the nature of HMAs, which has often led to court precedents indicating whether such agreements are or are not agency agreements in nature, in Mexico there is no discussion on these matters. Nevertheless, in Mexico, the nature of an HMA is more similar to that of a commercial agency agreement than to a professional services agreement, since in a professional services agreement a consideration is paid to the service provider for the rendering of the services but no payment is made to the client, and therefore the commercial agency agreement as a flexible and dynamic instrument allows the parties to agree on provisions that result in a payment to the principal (hotel owner) that ultimately implies the fiduciary duty of the agent (hotel operator) as set forth in the Commercial Code. Additionally, since the nature of an HMA is that of a commercial agency agreement, then specific performance of the HMA could be claimed for in accordance with Article 280 of the Commercial Code, which states that agents are required to personally execute all the acts in connection with the commercial agency agreement.
Furthermore, tortious interference is not an action regulated under Mexican law and therefore a cause of action for damages and loss profits (consequential and incidental damages) shall be pursued, establishing certainty and causation.
With respect to third-party claims, it should be considered that the parties can agree to hold safe and harmless the other party of claims of certain type with no limitation.
In Mexico, all agreements granting temporary use over real properties are governed by the local laws of the state in which the real property is located as a public policy mandatory disposition, and therefore no choice of law can be made over such agreement. On the other hand, non-property related agreements can be subject to foreign law, which enables the parties to negotiate the law that best suits their interests, as long as such disposition does not violate public policy under Mexican law.
Finally, arbitration is a frequent choice for dispute resolution in HMAs; nevertheless, the associated high costs warrant careful consideration. Furthermore, mediation is an in-development practice in Mexico, which does not make it suitable for complex matters, leading us to a classical dispute resolution in courts. Nevertheless, as a preventive step a dispute board comprised by three professionals in the hospitality industry for operation items could be agreed in the HMA, and this board could speed up strictly operational disputes to contribute to a dynamic relationship of the parties.
In Mexico, the hospitality sector has aligned itself with international practice; nevertheless, Mexican legal framework particularities impact on legal structures. In this regard, the most important items to address in the hospitality sector in Mexico from a legal standpoint are as follows:
- restrictions on foreign individuals or entities acquiring real property in the restricted zone, which can be addressed either through a Mexican entity or through a trust;
- the obligation to formalise the transfer of real property through a public deed granted by a notary public, as well as the registration before the Public Registry of Property so that the transfer has effects on third parties or to complete such transfer specifically for the state of Quintana Roo;
- the possibility to held a concession for the exclusive use over the ZOFEMAT for beach front hotels;
- the prohibition on terms longer than 20 years for lease agreements in Mexico (with the exception of the state of Nuevo Leon);
- the requirement to file before the Mexican authorities assignments of or licence agreements over IP;
- the obligation of service providers to guide themselves on the provisions set forth on certain Mexican e-commerce standards;
- the election of (x) mezzanine financing, (y) a standard hotel loan or (z) a permanent loan;
- the thorough review of labour structures due to the Outsourcing Reform to avoid any tax or even criminal liability;
- the election of governing law for non-property related agreements since all property-related agreements shall be governed by the laws of the state in which the real property is located;
- legal remedies to be indicated in the agreements since no business interruption insurance can be acquired in Mexico; and
- the nature of HMAs as commercial agency agreements with a fiduciary duty, and consequently the ability to require specific performance on courts.
Finally, the major challenge in the upcoming months will be the publication of the Timeshare NOM, which could lead to amendments in all the forms of timeshare services agreements that have to be registered before the Federal Consumer Protection Agency, and consequently the amendment of all timeshare services agreements already executed by timeshare companies with their clients.
1 Carlos Ibarra, Juan M Álvarez, Jaime Rodríguez, Rodrigo de los Ríos and Juan Miguel Martínez are partners, Fernando Frías, José Mayagoitia, Ricardo Koller and Mariano Sotomayor are associates and Andrea Gutiérrez is a law clerk at Ibarra, del Paso & Gallego, SC.
2 Note that although the notary public attests transfers of real estate, his or her public faith pertains to the legal act itself and not to the background originating it (i.e., the chain of title or matters that are not recorded with the Registry).
3 Although the General Law of Commercial Companies foresees four other forms of entities, these two are the most commonly used as they afford 'corporate veil' protection to their incorporators, who (in the absence of a fraudulent purpose or duress) are liable only to the extent of their contribution.