Lease Issues Related to Initial Alterations—A Tenant’s Perspective

Leasing new space can be a stressful and expensive endeavor for any tenant; particularly the initial buildout phase. To ensure that a tenant will be able to build out its space in a timely fashion and in the manner it desires, there are a number of issues which should be addressed in the lease. This article will discuss tenant considerations when negotiating a lease, so as to avoid pitfalls related to landlord constraints on alterations that may: (i) result in delays; (ii) cost overruns; (iii) prevent tenant from constructing what it desires; and/or (iv) at worst causing the space to be non-functional for tenant’s intended business.

Tenants should always negotiate that the landlord will reasonably approve all aspects of alterations. With that said, if a landlord insists that its approval of alterations affecting the building’s structure, systems and/or exterior be in its “sole” discretion, tenant should, prior to execution of the lease, seek landlord’s pre-approval of “concept” or “design” plans to attach as an exhibit to the lease, subject only to landlord’s approval of a full set of construction drawings. If the construction drawings are in line with the pre-approved “concept” or “design” plans, landlord should have no right to object, even to aspects that affect the building’s structure, systems and/or exterior, so long as the construction drawings are substantially consistent with the pre-approved plans.

Furthermore, the lease should ensure that the landlord has finite periods of time to approve (or reject) tenant’s plans, so that landlord does not delay the construction process and eat into any free rent period. Landlord’s time frame for approval should be shorter for resubmissions since landlord previously reviewed the plans. Landlord should also provide reasonable specificity as to why it disapproves any aspect of tenant’s plans, in writing. Moreover, landlord’s failure to timely approve plans should result in its deemed approval thereof or constitute an improper delay.

Typically, in order to file plans to obtain necessary governmental permits, a landlord must sign-off on paperwork and plans to be filed by tenant with the requisite governmental authority.  Landlords should agree to reasonably and promptly cooperate with tenant to obtain permits.  Additionally, if the certificate of occupancy for the space must be changed to allow for tenant’s use, the parties should negotiate whose responsibility it will be to obtain same and at whose cost.  If tenant undertakes the task, landlord should reasonably cooperate with specific timelines for responding to a request for cooperation; failing which, tenant would be entitled to a per diem liquidated damages amount or free rent or to act as landlord’s attorney in fact (if an acceptable remedy in the jurisdiction).

If the lease requires tenant to be open by a date certain, such date should be subject to delays caused by landlord (including failing to meet dates for approvals and/or cooperation) and all other delays that are not within tenant’s reasonable control, including force majeure. Tenant should not be in default for failure to open if such failure is caused by landlord or is not within tenant’s control! Also, since delays will increase tenant’s cost to construct, tenant should negotiate additional free rent for each day it is delayed from performing its work and/or opening for business resulting from landlord delays, including delays due to open building permits and/or building violations not caused by tenant.

If tenant’s build out requires access to parts of the building or project outside of its space – for example, to install HVAC, elevator pits or reinforce floors – landlord should be required to grant such access, together with the right to access such spaces during the term for maintenance, repairs and replacements. Landlords will typically require advance notice of such access, which should be reasonably granted, however, in the case of an emergency tenant should have immediate access either without notice or with notice as is reasonable under the circumstances.

If access to another tenant’s space is required, this should be explicitly raised during the negotiations, to avoid arguments and serious delays.

If a landlord is granting an improvement allowance to tenant for the payment of the alterations, the lease must specify whether same may be applied to soft and hard costs and, if not used, whether tenant may take a credit against rent in the amount of the unused portion. The lease must also be clear on when such improvement allowance will be paid and under what circumstances. Ideally, landlord will agree to pay all or any portion of the allowance directly to tenant up front. If not, the lease should provide for certain progress payments based on tenant’s achievement of specific milestones (i.e., 50% of work complete, opening for business, delivering evidence of governmental sign offs to the work, etc.). Note that most landlords will require evidence of final sign offs and partial and final lien waivers and sometimes even architect certificates as to the status of the work in connection with advancing any portion of the allowance. Bear in mind that if landlord is funding the allowance through its own financing, the requirements to draw under landlord’s loan will need to be complied with and any such requirements included in the lease may not be negotiable. In any event, from tenant’s perspective, the fewer conditions to payment the better.

Generally, an allowance will not fund the entire tenant build out. In these cases, tenant will typically bear all costs in excess of the allowance; however, if landlord agrees to perform the work, tenant should ensure that landlord reasonably incurs such costs to be applied against the allowance. One way to control such costs is to allow tenant to approve a construction budget, be involved in the bidding process and approve the chosen bid. Further, if during construction any costs vary from the approved construction budget, tenant should have further approval rights over same. If, however, tenant requests a change order during construction, any increased cost should be borne by tenant, but it can get complicated when a change of law or building code mid-construction increases a cost, which should also be negotiated in the lease.

If a tenant is able to negotiate these concepts in its favor, it will go a long way to ensuring a smooth construction project and will reduce the likelihood of disputes between landlord and tenant causing unnecessary delays and costs.

Andrea Gendel and Benjamin Teig are partners in Pryor Cashman’s Real Estate Group. The views expressed here are the author’s own and not that of ALM Real Estate Group.