'As Is' Deals: What Do the Parties Really Mean?

A typical scenario is one in which there are multiple shopping centers in a particular trade area, and each one is closely competitive with the others. In one particular shopping center, which has been opened and operating for some period of time, a potential leasing opportunity arises in a shop space location. The landlord, knowing that its shopping center has historically had a good occupancy level, determines to offer the shop space in an “as is/where is” condition; and the tenant, concluding there is an opportunity to enter into the marketplace, engages the landlord in negotiations to execute a lease.

One might question why the necessity for any discussions as to the delivery conditions of the premises in an “as is/where is” deal, since the intent of the parties is to keep things simple: the landlord turns over the premises in its current condition; the tenant accepts the condition of the premises immediately upon turnover by the landlord, starts its build-out and opens for business in the premises. The concerns (or lack thereof) of both the landlord and tenant in this scenario may not be as “cut and dried” as they believe them to be. Contradictions and problems will occur if the landlord requires in the lease agreement that when the landlord turns the premises over, the new tenant will be responsible for any and all repair or replacement of items in the premises in order for the tenant to obtain all the requisite governmental approvals to open for business, and the landlord will be responsible for such items during the lease term.

In negotiating the lease agreement, the landlord and tenant must allocate their respective ongoing maintenance, repair and replacement obligations for the premises during the lease term in relationship to the “as is” turnover condition of the premises. This allocation gives rise to numerous questions. Does the landlord intend that the tenant make exterior or structural changes or repairs to the premises during the tenants' build-out? Does the tenant have in its budget any amount set aside for code compliance issues or repair of items that are normally the landlord's ongoing maintenance obligations?

How do the parties negotiate lease terms that adequately incorporate these seemingly contradictory concepts in a manner that properly limits the scope of future economic liabilities for both landlord and tenant during the administration of the lease? In order to address these concerns, two concepts should be discussed during lease negotiations: (i) delivery conditions; and (ii) inspection of the premises.

Delivery Conditions

Typically, form lease provisions for maintenance, repair and replacement obligations for a shop space provide that the landlord will be responsible for, among other things, the roof, roof membrane, structure and exterior elements of the premises. This is in part due to the multi-tenant nature of the typical shop space so that the landlord performs such maintenance, repair and replacement work because of its (a) ability to get economies of scale work, (b) ability to maintain control of such work to avoid any unnecessary duplication, and (c) desire to ensure that the work gets done in a proper manner and on a timely basis.

Based upon the foregoing reasons, a couple of questions arise. Why would a landlord want a tenant to do work during its build-out of the premises for which the landlord agrees to be responsible during the lease term? If the tenant performs the work, the manufacturers' and/ or contractors' warranties may be voided. For example, a roof warranty or HVAC warranty may be voided if the tenant's contractor performs initial repairs that do not conform to the manufacturer's specifications.

Why would a tenant agree to perform its build-out of the premises, knowing of deficiencies in the landlord's maintenance obligations (ie leaking roof) and give the landlord notice thereof during the lease term? If the tenant waits to give notice of a defect to the landlord to perform maintenance or repair work after the tenant opens for business, the tenant's improvements may be damaged by the repair of the defect (eg leaky roof), not to mention the potential negative impact on the tenant's business (and the landlord's percentage rent) if a newly-opened store looks like it is still under construction.

Solutions

• Punch list. After the tenant inspects the “as is” premises, the landlord receives notice from the tenant in the form of a punch list (as further discussed below) as to the nature and scope of what repairs the tenant needs done. Then the landlord can determine (prior to closing the deal) whether or not any existing condition or element of repair corresponds to the landlord's ongoing maintenance, repair and replacement obligations for the premises.
• Plan approval. The landlord requires the tenant to submit its plans and specifications to the landlord for review and approval prior to the commencement of the tenant's build-out. Then the landlord can ascertain the nature and scope of the tenant's intended work to determine whether or not any such work affects any of the landlord's maintenance, repair and replacement obligations during the lease term.
• Landlord performs limited scope of work. If the tenant's plans require any exterior or structural work, such work could be performed by the landlord's contractor and reimbursed by the tenant; or in the alternative, the work could be performed by a contractor approved by the landlord in advance.
• Kick-out right. If the scope of work to the premises by either party, as determined by the inspection, exceeds a certain dollar threshold, then either party could terminate the lease; in the alternative, the nonterminating party could void the other party's termination by agreeing to pay the excess amounts above the threshold (which could be in cash or amortized into the rent schedule).
• Minimum standards. The landlord and tenant could agree to a minimum standard for the delivery condition, eg that the premises be structurally sound, code compliant and watertight. The significance of the minimum standard relates directly to the administration of the parties' lease obligations during the lease term.

Inspection

One of the first issues to address regarding inspection is whether or not the 'as is' premises have been vacated by the prior occupant. In situations where the premises are vacant, the parties can more readily inspect (i) what is available upon delivery of the premises by the landlord (eg, improvements such as interior walls, plumbing, mechanical and electrical fixtures), (ii) what condition those items are in, and (iii) what, if anything, will need to be removed or repaired by either party.

Conversely, in situations where the premises are currently occupied by an existing tenant who is expected to vacate the premises in the near future, more unique concerns arise as to (i) what fixtures and improvements are to be removed, repaired or replaced by the existing tenant and (ii) in what condition does the existing tenant have to return the premises upon vacating them. In these situations, the landlord should review the existing tenant's lease obligations regarding the condition of the premises at lease termination and advise its property management personnel to be present when the tenant vacates the premises to ensure compliance with the lease terms.

Obviously, the landlord does not want the existing tenant to damage the premises or remove items such as electrical panels, security systems, HVAC systems, light fixtures, or telecommunications systems, which became the landlord's property when they were affixed to the premises. Similarly, the new tenant needs to ascertain what will be remaining in the premises in order to prepare its construction budget and construction schedule.

The parties can conduct a walk-through for purposes of preparing a punch list of items that the landlord needs to (or is willing to) complete prior to the tenant's acceptance of the premises.

In those situations where the premises are currently occupied by an existing tenant, the landlord and tenant can conduct a “pre-delivery” inspection prior to the date the existing tenant vacates the premises and use that inspection as a “base line” for determining what, if anything, needs to be done to the premises at the time the landlord can actually tender possession of the premises to the new tenant. The landlord can also use the inspection to enforce the existing tenant's lease obligations with regard to vacating the premises to ensure that it is done properly, and to limit the scope of work, if any, required by the landlord for the new tenant. In addition, this will be useful to the tenant for purposes of determining its construction budget.

Whether the premises are vacant or not, the inspection should include, but not be limited to, items such as the roof membrane and structure, electrical systems such as the panels and breakers, light fixtures including outlets, mechanical systems, such as the HVAC, and plumbing systems. Inspection for code compliance issues would also be extremely helpful. The notion of the “pre-delivery inspection” is useful during the lease negotiations because it could be used as part of a potential kick-out clause (as discussed above) if the scope of the proposed work by either landlord or tenant is too extensive or expensive.

The inspection should be extremely thorough. Often when a landlord and tenant are negotiating the basic terms of the deal and they meet at the premises to “take a look around,” the tenant is viewing (rather than inspecting) the premises to determine the basic scope of both its tenant improvement work and its budget, without considering the structural integrity, roof conditions or code compliance or the cost of any thereof.

Summary

It is evident that all potential lease transactions should be thoroughly reviewed and analyzed on a case-by-case basis. A “good deal” that is set up to be an “as is/where is” turnover condition could eventually become an economic liability. Therefore, to avoid future potential conflicts, the landlord and tenant should attempt during lease negotiations to define clearly the interrelationship of the condition of the premises at turnover and each party's respective maintenance, repair and replacement obligations during the lease term.

In today's competitive commercial real estate market, landlords and tenants spend much time and effort to structure lease transactions to add value to their respective portfolios. They each factor into their economic analysis relevant concerns such as rent, construction costs, construction build-out periods, operating expenses and revenue forecasts. An additional factor that should be considered in this process is the cost incurred by both parties to administer the lease obligations during the lease term for ongoing maintenance, repair and replacement items.

In many lease transactions the landlord agrees to build out some type of shell condition (raw, vanilla, turnkey or variation thereof) prior to delivery of the premises to the tenant. Thereafter, the landlord and tenant's ongoing maintenance, repair and replacement obligations in the lease typically correspond to their build-out obligations and warranties on workmanship (ie the landlord does the structural and exterior, and the tenant does nonstructural and interior).

This article will: 1) explore some of the subtle issues that arise in those deals structured in the “as is/where is” format, and 2) discuss negotiating points that could benefit both the landlord and tenant, rather than burdening them, during the administration of such a lease throughout its term.

A typical scenario is one in which there are multiple shopping centers in a particular trade area, and each one is closely competitive with the others. In one particular shopping center, which has been opened and operating for some period of time, a potential leasing opportunity arises in a shop space location. The landlord, knowing that its shopping center has historically had a good occupancy level, determines to offer the shop space in an “as is/where is” condition; and the tenant, concluding there is an opportunity to enter into the marketplace, engages the landlord in negotiations to execute a lease.

One might question why the necessity for any discussions as to the delivery conditions of the premises in an “as is/where is” deal, since the intent of the parties is to keep things simple: the landlord turns over the premises in its current condition; the tenant accepts the condition of the premises immediately upon turnover by the landlord, starts its build-out and opens for business in the premises. The concerns (or lack thereof) of both the landlord and tenant in this scenario may not be as “cut and dried” as they believe them to be. Contradictions and problems will occur if the landlord requires in the lease agreement that when the landlord turns the premises over, the new tenant will be responsible for any and all repair or replacement of items in the premises in order for the tenant to obtain all the requisite governmental approvals to open for business, and the landlord will be responsible for such items during the lease term.

In negotiating the lease agreement, the landlord and tenant must allocate their respective ongoing maintenance, repair and replacement obligations for the premises during the lease term in relationship to the “as is” turnover condition of the premises. This allocation gives rise to numerous questions. Does the landlord intend that the tenant make exterior or structural changes or repairs to the premises during the tenants' build-out? Does the tenant have in its budget any amount set aside for code compliance issues or repair of items that are normally the landlord's ongoing maintenance obligations?

How do the parties negotiate lease terms that adequately incorporate these seemingly contradictory concepts in a manner that properly limits the scope of future economic liabilities for both landlord and tenant during the administration of the lease? In order to address these concerns, two concepts should be discussed during lease negotiations: (i) delivery conditions; and (ii) inspection of the premises.

Delivery Conditions

Typically, form lease provisions for maintenance, repair and replacement obligations for a shop space provide that the landlord will be responsible for, among other things, the roof, roof membrane, structure and exterior elements of the premises. This is in part due to the multi-tenant nature of the typical shop space so that the landlord performs such maintenance, repair and replacement work because of its (a) ability to get economies of scale work, (b) ability to maintain control of such work to avoid any unnecessary duplication, and (c) desire to ensure that the work gets done in a proper manner and on a timely basis.

Based upon the foregoing reasons, a couple of questions arise. Why would a landlord want a tenant to do work during its build-out of the premises for which the landlord agrees to be responsible during the lease term? If the tenant performs the work, the manufacturers' and/ or contractors' warranties may be voided. For example, a roof warranty or HVAC warranty may be voided if the tenant's contractor performs initial repairs that do not conform to the manufacturer's specifications.

Why would a tenant agree to perform its build-out of the premises, knowing of deficiencies in the landlord's maintenance obligations (ie leaking roof) and give the landlord notice thereof during the lease term? If the tenant waits to give notice of a defect to the landlord to perform maintenance or repair work after the tenant opens for business, the tenant's improvements may be damaged by the repair of the defect (eg leaky roof), not to mention the potential negative impact on the tenant's business (and the landlord's percentage rent) if a newly-opened store looks like it is still under construction.

Solutions

• Punch list. After the tenant inspects the “as is” premises, the landlord receives notice from the tenant in the form of a punch list (as further discussed below) as to the nature and scope of what repairs the tenant needs done. Then the landlord can determine (prior to closing the deal) whether or not any existing condition or element of repair corresponds to the landlord's ongoing maintenance, repair and replacement obligations for the premises.
• Plan approval. The landlord requires the tenant to submit its plans and specifications to the landlord for review and approval prior to the commencement of the tenant's build-out. Then the landlord can ascertain the nature and scope of the tenant's intended work to determine whether or not any such work affects any of the landlord's maintenance, repair and replacement obligations during the lease term.
• Landlord performs limited scope of work. If the tenant's plans require any exterior or structural work, such work could be performed by the landlord's contractor and reimbursed by the tenant; or in the alternative, the work could be performed by a contractor approved by the landlord in advance.
• Kick-out right. If the scope of work to the premises by either party, as determined by the inspection, exceeds a certain dollar threshold, then either party could terminate the lease; in the alternative, the nonterminating party could void the other party's termination by agreeing to pay the excess amounts above the threshold (which could be in cash or amortized into the rent schedule).
• Minimum standards. The landlord and tenant could agree to a minimum standard for the delivery condition, eg that the premises be structurally sound, code compliant and watertight. The significance of the minimum standard relates directly to the administration of the parties' lease obligations during the lease term.

Inspection

One of the first issues to address regarding inspection is whether or not the 'as is' premises have been vacated by the prior occupant. In situations where the premises are vacant, the parties can more readily inspect (i) what is available upon delivery of the premises by the landlord (eg, improvements such as interior walls, plumbing, mechanical and electrical fixtures), (ii) what condition those items are in, and (iii) what, if anything, will need to be removed or repaired by either party.

Conversely, in situations where the premises are currently occupied by an existing tenant who is expected to vacate the premises in the near future, more unique concerns arise as to (i) what fixtures and improvements are to be removed, repaired or replaced by the existing tenant and (ii) in what condition does the existing tenant have to return the premises upon vacating them. In these situations, the landlord should review the existing tenant's lease obligations regarding the condition of the premises at lease termination and advise its property management personnel to be present when the tenant vacates the premises to ensure compliance with the lease terms.

Obviously, the landlord does not want the existing tenant to damage the premises or remove items such as electrical panels, security systems, HVAC systems, light fixtures, or telecommunications systems, which became the landlord's property when they were affixed to the premises. Similarly, the new tenant needs to ascertain what will be remaining in the premises in order to prepare its construction budget and construction schedule.

The parties can conduct a walk-through for purposes of preparing a punch list of items that the landlord needs to (or is willing to) complete prior to the tenant's acceptance of the premises.

In those situations where the premises are currently occupied by an existing tenant, the landlord and tenant can conduct a “pre-delivery” inspection prior to the date the existing tenant vacates the premises and use that inspection as a “base line” for determining what, if anything, needs to be done to the premises at the time the landlord can actually tender possession of the premises to the new tenant. The landlord can also use the inspection to enforce the existing tenant's lease obligations with regard to vacating the premises to ensure that it is done properly, and to limit the scope of work, if any, required by the landlord for the new tenant. In addition, this will be useful to the tenant for purposes of determining its construction budget.

Whether the premises are vacant or not, the inspection should include, but not be limited to, items such as the roof membrane and structure, electrical systems such as the panels and breakers, light fixtures including outlets, mechanical systems, such as the HVAC, and plumbing systems. Inspection for code compliance issues would also be extremely helpful. The notion of the “pre-delivery inspection” is useful during the lease negotiations because it could be used as part of a potential kick-out clause (as discussed above) if the scope of the proposed work by either landlord or tenant is too extensive or expensive.

The inspection should be extremely thorough. Often when a landlord and tenant are negotiating the basic terms of the deal and they meet at the premises to “take a look around,” the tenant is viewing (rather than inspecting) the premises to determine the basic scope of both its tenant improvement work and its budget, without considering the structural integrity, roof conditions or code compliance or the cost of any thereof.

Summary

It is evident that all potential lease transactions should be thoroughly reviewed and analyzed on a case-by-case basis. A “good deal” that is set up to be an “as is/where is” turnover condition could eventually become an economic liability. Therefore, to avoid future potential conflicts, the landlord and tenant should attempt during lease negotiations to define clearly the interrelationship of the condition of the premises at turnover and each party's respective maintenance, repair and replacement obligations during the lease term.