Commercial space is rarely in turnkey condition for the tenant. As a result, landlords and tenants must negotiate leasehold improvements in order for the leasing transaction to move forward. This can affect new leases, amendments or renewals of existing leases. Below are some tips when negotiating and drafting the work letter for leasehold improvement responsibilities:
Plans. Your job is easier if the plans and specifications are approved by the parties and permitting authorities when the lease is executed. If they are not approved at that time (as is typical), you must define the process by which the plans and specs will be created and approved. One of the parties should be responsible for the initial plan set. From there, a backand- forth review and approval process with realistic deadlines should be specified. Keep in mind that failure to object to plans or revisions could be deemed an approval, so schedule accordingly.
Budget. The plans and specifications for the work will affect the project budget, so an approval process similar to that above should also apply to the budget. Further, it should clearly state who pays for work in excess of the agreed-upon budget.
Improvement Allowance. It is not uncommon for a landlord to offer the tenant an improvement allowance, which is a credit against the cost of the work. The work letter should clarify how the allowance gets paid. The mechanics of the payments can impact a party’s cashflow. For example, does the allowance get paid to the tenant at the conclusion of the work such that the tenant has to fund the construction out-of-pocket and seek reimbursement from the landlord? Or is the allowance paid directly to the contractor in increments per the draw schedule?
Contractor. The work letter must identify which party is responsible for hiring the contractor and causing the permitting and completion of the work. This element will also address how to best structure the tenant improvement allowance payments, and whether the landlord is protected from construction liens for tenant improvements. It may also be prudent to name the contractor who will perform the work.
Changes. It’s advisable to have a well-drafted provision addressing change orders. Items discovered in the field or during permitting can necessitate change orders, which in turn can impact the budget and construction schedule. It should be clear who bears the risk for price adjustments and construction delays caused by change orders.
Deadlines. A realistic construction schedule is imperative, and should include an estimated completion date and possibly an outside completion date. A deadline is meaningless unless the work letter identifies the remedies available to the other party if the deadline is not met. Deadlines can be subject to extension under circumstances outside of a party’s control, but not always.
These are just some of the issues to consider when negotiating commercial leasehold improvements. Whether you’re a landlord or tenant, you’d be well advised to consult with an experienced real estate attorney prior to finalizing a lease agreement or any legally-binding document.
(Edward Canterbury is a Florida Bar board-certified real estate specialist. He handles all aspects of real estate law with a focus on commercial and residential development, acquisitions, finance, survey matters, title insurance and commercial leases. Canterbury is a stockholder with Henderson, Franklin, Starnes & Holt and a member of the firm’s executive committee.)