It's Just a Phase: Issues and Answers for Landlords When Phasing a Project

A tenant, however, may argue that the landlord cannot elect to abandon the construction, terminate the lease, and then change its mind and enter into a new lease with a competitor of the tenant or another occupant who is willing to pay more rent. If this argument is raised, the landlord can add the following language in the above provision:

Notwithstanding the above, should Landlord terminate this Lease as provided above, and, within two years from the date of termination of the Lease, recommence the construction of the portion of the Shopping Center which contains the Premises, Tenant shall have the right to reinstate this Lease upon written notice to Landlord delivered within 30 days after notice of Landlord's intention to recommence construction.

Whether or not the landlord adds a contingency for the abandonment of the phase in question, the landlord must protect itself in how it defines the tenant's proportionate share of common area maintenance charges and taxes.

If the ultimate site plan indicates a shopping center of 300,000 square feet, for example, but the tenant in question is in the first phase containing only 150,000 square feet, and the second phase will not be built for another year, the tenant's proportionate share for computing additional rent should be based only on the phase currently built. In other words, the denominator of the fraction should reflect only the smaller completed phase, and therefore the tenant's proportionate share will be a larger percentage. Otherwise, in the above example, the landlord would end up paying for 50% of the expenses of the shopping center that are attributable to the undeveloped land, even if this land is never developed. Suggested language may look like the following:

Tenant acknowledges that the Shopping Center may be developed in Phases as shown on Exhibit B. Tenant acknowledges that Phase II may not be developed at the same time as Phase I which contains the Premises. Therefore, the Common Areas located in Phase II might not be completed and any square footage of buildings in said area will be subtracted from the formula for determining Tenant's Proportionate Share of Common Area Charges and Real Estate Taxes until built. Notwithstanding the foregoing, in connection with the calculation of Tenant's Proportionate Share of Common Area Charges or Real Estate Taxes, the denominator of such fraction shall be reduced by the gross leasable area of those portions of the Shopping Center for which Landlord is not obligated to incur costs for such Real Estate Taxes or Common Area Charges. The denominator in the above fraction shall increase or decrease with the further increase or decrease in the size of the Shopping Center.

The last two sentences of this language should be considered whether or not the shopping center is built in phases in order to protect the landlord in those situations where there may be an outparcel or anchor tenant that either obtains a separate tax parcel or maintains a defined area of the common areas, and as a result, does not contribute to common area charges and/or real estate taxes for the shopping center as a whole.

Finally, as stated at the beginning of this article, one of the two phases may be built by a department store anchor that purchases its parcel. While this is more customary in a mall situation, it is common in community centers as well where a megastore or department store insists on developing its own parcel. In this situation, the developer and the anchor will enter into a Reciprocal Easement Agreement that may impose restrictions, obligations and rights on the tenants of the developer's portion of the shopping center. Since the department store might not be built at the time the first phase of the shopping center is being developed, the landlord should protect itself in the event that this possibility may arise by adding the paragraph set forth above, and also including the following language to the lease of tenants in an early phase of the development:

Tenant acknowledges that the Shopping Center may be developed in Phases as shown on Exhibit B, and that Phase II may be sold or developed by a party other than Landlord. If such is the case, Tenant agrees to the Lease being subject to a Reciprocal Easement Agreement (“REA”), provided the REA does not adversely affect Tenant's ability to operate in the Premises as set forth in this Lease.

The landlord might also consider adding language to allow the landlord (or others) to perform work in the shopping center when construction begins in the next phase of development, and not have to worry about violating lease provisions that seek to prevent certain conduct in the common areas. A typical provision may read as follows:

Landlord may temporarily close parts of the Common Areas for such periods of time as may be necessary for (i) temporary use as a work area in connection with the construction of buildings or other improvements within the Shopping Center or contiguous property; (ii) repairs or alterations in or to the Common Areas or to any utility-type facilities; (iii) preventing the public from obtaining prescriptive rights in or to the Common Areas; (iv) emergency or added safety reasons; or (v) doing and performing such other acts as in the use of good business judgment Landlord shall determine to be appropriate for the Shopping Center; provided, however, that Landlord shall use reasonable efforts not to unduly interfere with or disrupt Tenant's business.

Of course, phased construction, especially where more than one party is responsible for the work, also raises myriad issues involving coordination and other construction, which are outside the scope of this article, but are no less important than the ones discussed above.

In today's larger community centers, the developer is often faced with the need to construct the shopping center in phases, either to ensure adequate tenancies before undertaking the next portion of the center or to negotiate a sale of a portion of the shopping center to a large department store user who has its own agenda on when to construct its store. In either case, it is necessary for the developer to address the construction timing of the various phases and to deal with the issue of whether certain phases will be built at all. This article focuses on certain provisions the landlord needs to incorporate into its leases to protect itself in these situations.

The threshold concern relates to the possibility that a particular phase, or portion of the shopping center, may not be built at all. Perhaps the landlord hits a snag in its leasing program, and the lease it is negotiating ends up being one of the relatively few leases in the current phase. Perhaps the landlord has difficulty obtaining a construction loan and decides to forego the phase that contains the lease in question and concentrate on filling up another phase in order to reach leasing requirements imposed by the construction lender or permanent lender of the first phase.

In either case, the landlord needs to protect itself from executing a lease and then not being able to fulfill its obligations to the tenant. The landlord must make sure it does not have any liability for damages, and that the tenant has no rights to force the landlord to specifically perform its obligations under the lease. The landlord should, in certain situations, be allowed to terminate the lease and have no further obligations to the tenant. A suggested provision may read as follows:

Notwithstanding anything contained in this Lease to the contrary, Tenant acknowledges that if Landlord shall, at any time, in its sole and absolute discretion, abandon the construction of the entire Shopping Center or that portion of the Shopping Center in which the Premises are expected to be located, Landlord may terminate this Lease by giving 30 days notice of such election to Tenant. If such notice is given, this Lease and the rights and obligations of the parties pursuant to this Lease shall cease and terminate without need for the execution of any further or other instrument, but if Landlord shall so request, Tenant shall execute an instrument in recordable form whereby Tenant releases and surrenders all right, title and interest which it may have in and to the Premises under this Lease or otherwise and in and to the Shopping Center.

This provision may not sit well with a more sophisticated tenant. First of all, the tenant may be incurring expenses in preparing plans and specifications for its store and may be foregoing other opportunities by waiting to see what the landlord is going to do. Therefore, it is reasonable to require the landlord to elect whether or not it will exercise its opportunity to abandon the construction of the phase in question within a specified period from the date of signing the lease.

A tenant, however, may argue that the landlord cannot elect to abandon the construction, terminate the lease, and then change its mind and enter into a new lease with a competitor of the tenant or another occupant who is willing to pay more rent. If this argument is raised, the landlord can add the following language in the above provision:

Notwithstanding the above, should Landlord terminate this Lease as provided above, and, within two years from the date of termination of the Lease, recommence the construction of the portion of the Shopping Center which contains the Premises, Tenant shall have the right to reinstate this Lease upon written notice to Landlord delivered within 30 days after notice of Landlord's intention to recommence construction.

Whether or not the landlord adds a contingency for the abandonment of the phase in question, the landlord must protect itself in how it defines the tenant's proportionate share of common area maintenance charges and taxes.

If the ultimate site plan indicates a shopping center of 300,000 square feet, for example, but the tenant in question is in the first phase containing only 150,000 square feet, and the second phase will not be built for another year, the tenant's proportionate share for computing additional rent should be based only on the phase currently built. In other words, the denominator of the fraction should reflect only the smaller completed phase, and therefore the tenant's proportionate share will be a larger percentage. Otherwise, in the above example, the landlord would end up paying for 50% of the expenses of the shopping center that are attributable to the undeveloped land, even if this land is never developed. Suggested language may look like the following:

Tenant acknowledges that the Shopping Center may be developed in Phases as shown on Exhibit B. Tenant acknowledges that Phase II may not be developed at the same time as Phase I which contains the Premises. Therefore, the Common Areas located in Phase II might not be completed and any square footage of buildings in said area will be subtracted from the formula for determining Tenant's Proportionate Share of Common Area Charges and Real Estate Taxes until built. Notwithstanding the foregoing, in connection with the calculation of Tenant's Proportionate Share of Common Area Charges or Real Estate Taxes, the denominator of such fraction shall be reduced by the gross leasable area of those portions of the Shopping Center for which Landlord is not obligated to incur costs for such Real Estate Taxes or Common Area Charges. The denominator in the above fraction shall increase or decrease with the further increase or decrease in the size of the Shopping Center.

The last two sentences of this language should be considered whether or not the shopping center is built in phases in order to protect the landlord in those situations where there may be an outparcel or anchor tenant that either obtains a separate tax parcel or maintains a defined area of the common areas, and as a result, does not contribute to common area charges and/or real estate taxes for the shopping center as a whole.

Finally, as stated at the beginning of this article, one of the two phases may be built by a department store anchor that purchases its parcel. While this is more customary in a mall situation, it is common in community centers as well where a megastore or department store insists on developing its own parcel. In this situation, the developer and the anchor will enter into a Reciprocal Easement Agreement that may impose restrictions, obligations and rights on the tenants of the developer's portion of the shopping center. Since the department store might not be built at the time the first phase of the shopping center is being developed, the landlord should protect itself in the event that this possibility may arise by adding the paragraph set forth above, and also including the following language to the lease of tenants in an early phase of the development:

Tenant acknowledges that the Shopping Center may be developed in Phases as shown on Exhibit B, and that Phase II may be sold or developed by a party other than Landlord. If such is the case, Tenant agrees to the Lease being subject to a Reciprocal Easement Agreement (“REA”), provided the REA does not adversely affect Tenant's ability to operate in the Premises as set forth in this Lease.

The landlord might also consider adding language to allow the landlord (or others) to perform work in the shopping center when construction begins in the next phase of development, and not have to worry about violating lease provisions that seek to prevent certain conduct in the common areas. A typical provision may read as follows:

Landlord may temporarily close parts of the Common Areas for such periods of time as may be necessary for (i) temporary use as a work area in connection with the construction of buildings or other improvements within the Shopping Center or contiguous property; (ii) repairs or alterations in or to the Common Areas or to any utility-type facilities; (iii) preventing the public from obtaining prescriptive rights in or to the Common Areas; (iv) emergency or added safety reasons; or (v) doing and performing such other acts as in the use of good business judgment Landlord shall determine to be appropriate for the Shopping Center; provided, however, that Landlord shall use reasonable efforts not to unduly interfere with or disrupt Tenant's business.

Of course, phased construction, especially where more than one party is responsible for the work, also raises myriad issues involving coordination and other construction, which are outside the scope of this article, but are no less important than the ones discussed above.