True Confessions of a Landlord’s Counsel: What a Commercial Tenant Needs to Know When Negotiating a
Part 8: Building Out the Tenant’s Space. Though it is not uncommon to have “turn-key” situations when leasing commercial space (i.e., where the premises does not need to be remodeled by the landlord or tenant prior to the tenant moving in), more often than not a tenant’s new space will not be perfect for its business and the tenant will want, at the minimum, some cosmetic improvements (new floor covering, painted walls and ceiling tiles replaced) or anywhere up to a full overhaul of the site, bringing the space to its studs and starting fresh. In any remodel situation the tenant will want to know at least a couple major issues up front.
The first critical point the tenant will need to know is when will the premises be available for the tenant? Is the space vacant or is there an existing tenant that needs to move out, and if so, what will the landlord do for the tenant if the existing tenant does not move out on time? Likewise, if the landlord needs to do any work on the premises, what happens if landlord does not complete the work on time? If tenant is looking for new space because its lease on its existing space is soon to expire, the tenant may not be in a position to risk any potential delays in landlord’s delivery of the new premises, unless landlord can somehow make the tenant whole for any losses to its business operations resulting from landlord’s delay. Such remedies by landlord may include paying for a move to temporary space that the landlord may have available until delivery can be made, or paying any holdover costs or other damages tenant may incur for failing to timely move out of it existing premises.
The second issue is that if any work needs to be done to the premises, the tenant will want to know who is going to do the work, landlord or tenant, and who is going to pay for it. This second issue can present a multitude of considerations and issues given the various complexities of planning, permitting and constructing tenant’s improvements, all of which will be subject to numerous factors including the current state of the premises, the desires of tenant for its space, the desires of landlord for the ambiance, maintenance and operations of its building, and perhaps, specific desires of the local planning department.Before the tenant signs any lease, it will want to know up front, as best as possible, how long it will take to build out the premises the way the tenant wants it, and what the cost of this will be to the tenant. These are issues that will need to be decided between the landlord and the tenant, and the best time to be making these decisions is when the parties are negotiating the letter of intent as opposed to the lease. The reason for this is that before entering into a binding lease, both parties should want to negotiate and determine upfront a clear timeline as to who will be obligated to do what and when, and what the potential remedies or penalties will be if a party fails to fulfill such obligations.
This timeline will typically have six stages which can make or break a deal. If the tenant is undertaking the work, the landlord will typically only be involved in some of the initial stages, including the design stage, the construction drawing stage, and the permitting stage. All the stages are as follows:
(1) The design stage. Generally with the help of a space planner, the tenant will determine the physical layout of its premises (walls, rooms, doorways, counters, trade fixtures, delivery areas, bathrooms, HVAC requirements, floor coverings, wall coverings, ceilings, lighting, etc.).
(2) The construction drawing stage. Once the design is agreed upon by the landlord and tenant, an architect and/or engineer will need to prepare construction drawings for approval by the parties before submission to the local planning department for approval.
(3&4) The permitting stage/construction contract bidding stage. Once the construction drawings are approved by landlord and tenant, the completed construction drawings will either be sent to the local planning department for the permitting stage or first sent out to bid to local contractors for the contract bidding stage. As the local planning department may make changes to the submitted plans in order for the plans to be approved, and such changes may affect the cost of construction, tenant may wish the planning approvals to be completed prior to the work going out to bid. Alternatively, if the work is not too complex, it may be preferable for the tenant to obtain the bids to determine the cost so that modifications to reduce costs can be made, or the project abandoned, before incurring the costs for submitting the plans for permit.
(5) The construction stage. Once the building permits are obtained and the construction contract executed by the successful bidder, the parties then enter into the construction stage. In the construction stage new unanticipated problems can be discovered during demolition or due to faulty or incomplete plans, or a tenant might change its mind as to what it wants built. Either of these scenarios will potentially increase the time and cost of construction, and require the parties’ agreement as to how to address these new timelines and costs.
(6) The delivery stage. At this stage landlord will notify the tenant that the premises will soon be substantially complete and set a date for the parties to participate in a walkthrough of the premises and create a checklist of any items that are yet to be completed, but do not prevent the tenant from moving in to the premises to begin its business operations.
Over the last 20 years sophisticated tenants have been pursuing a “Design/Build” method for the buildout of their sites which basically combines the design stage, construction drawing stage, construction bidding stage and permitting stage into one phase. Under this method the landlord and its contractor will have developed relationships with certain space planners, architects, engineers and sub-contractors who will work together with the tenant to develop the space plan and construction drawings for the premises at a specific cost. Proponents of this process believe that it results in a more cost effective and efficient process that benefits all of the parties involved.
Though many landlords’ form leases may have attachments called “Work Letters” that address some, if not all of the six build out stages noted above, they are typically one-sided and will have the tenant be responsible for all the costs associated with work involved in each stage, with landlord having most of the discretion as to how such stage proceeds, and no liability for landlord if the stage is not timely completed. At each stage, one or both parties will need to engage a third-party consultant to undertake a certain amount of work to determine whether or not there can be a “meeting of the minds” between landlord and tenant as to what can be built, and at whose cost. For this reason, even if a tenant is satisfied with all the other business terms that would otherwise be in a letter of intent regarding the leasing of the premises, tenants should forego the cost of hiring an attorney to negotiate a full lease between the parties and rather hire the attorney to set forth in the letter of intent how the parties will navigate through the process of building out the premises, so tenant will have a better understanding of all the up front costs that will be required to get into the premises, and to include an escape clause to get out of the lease if the costs start spiraling out of control. In the next two parts of our series we will dive a little deeper into each of the stages outlined above and identify what protections are needed for tenant for each stage.