Making the Work Letter Work

Whether because the landlord wishes to control all alterations made to its building, or the tenant wants cost certitude and minimum involvement in the build-out process, or both, on occasion the parties will agree to a 'turn-key' build-out, where the landlord constructs the build-out of the space at its sole cost and recovers that cost as a part of the rent over the initial term of the lease. A properly drafted 'turn-key' Work Letter (and the Lease of which it is part) must address the following matters:

1) Rent Commencement Date. The date on which rent starts to be payable is established as being not a specific date, but rather the date of substantial completion of the build-out (or earlier beneficial occupancy by the tenant). That is so because the landlord will control the progress of the build-out and the tenant will not want to be placed in the position of paying rent for space it cannot occupy. However, the tenant could delay substantial completion, whether as a result of change orders, long-lead items not available as needed to meet the landlord's construction schedule, tenant interference with landlord's contractor or subcontractors, or some other tenant-caused delay. Therefore, the lease should provide that in the event of such a delay caused by the tenant, the date of substantial completion will be deemed to be the date on which, but for the tenant delay(s), substantial completion of the build-out would have been attained. 'Substantial completion' is usually defined as being completion of the build-out except for normal 'punch list' items such as minor repairs, adjustments, and touch-ups, the making of which would not interfere with the tenant's beneficial occupancy and use of the premises. A careful tenant will also except from 'substantial completion' latent defects reported to the landlord within some specified period of time.

2) Plans and Specifications. Because the landlord is doing the turn-key build-out at its own expense and looking to recover the cost through rent, the plans and specifications for the build-out must obviously be fixed and costed before the lease is executed. If after lease execution the tenant requires changes to the plans and specifications and the landlord approves the changes, the lease should provide that the tenant bears any increase in cost occasioned by the changes and, as discussed above, such change orders will usually constitute a 'tenant delay.'

3) 'Base Building.' Because the build-out typically consists of improvements to space in a base building constructed or to be constructed by the landlord, it is important to define clearly what is included in the base building and consequently, what is to be included in the build-out work. The definition of 'base building' runs the gamut from a closed-in structure with neither heat nor light ('plain cold dark vanilla shell') to a building with mechanical, electrical, plumbing, and HVAC in place and, therefore, must be very carefully specified.

4) 'Building Standard.' Once the seam between base building and tenant improvements has been established, the next issue that must be addressed in a turn-key build-out is the quality of the materials and finishes to be used. Often the turn-key build-out will specify that the landlord is to use 'building standard' materials and finishes. Because the landlord is bearing the cost of the turn-key build-out and the tenant will be living with the results, it is obviously important for each to understand clearly what 'building standard' is for each material and finish. It is not unusual to have an exhaustive definition of 'building standard' attached as a schedule to the work letter, providing detailed specifications concerning such matters as partitions, flooring, ceiling, doors, frames and hardware, painting and wallcovering, millwork, light fixtures and switches, and life safety and mechanical systems.

5) Milestones. In the case of a building under construction, a tenant concerned about the landlord's adherence to the construction schedule may wish to require that certain specific construction milestones (e.g., existing building demolished, foundation poured, etc.) be agreed to and set forth in the Work Letter. If these milestones are not met, that failure can trigger either an abatement of rent (X days rent for each day of delay) or, in certain extreme cases, an option for the tenant to terminate the lease.

6) Restoration. Generally speaking, tenants are not required to remove the build-out construction (as opposed to subsequent alterations). Nevertheless, some landlords require that portions of the work that the landlord reasonably determines are specialized to the tenant's use of the premises be removed by the tenant at the end of the lease term at the tenant's expense. Interior staircases and raised computer room flooring are examples of such specialized improvements. Whether that determination by the landlord is to be made at the end of the lease term or at the time the plans are approved is often a bone of contention.

Next month's installment will address Work Letters in which the work is done at the tenant's expense by either the tenant or the landlord.

Myles Hannan, a member of this newsletter's Board of Editors, is a partner with Linowes and Blocher LLP (www.linowes-law.com), located in Bethesda, MD.

Part One of a Two-Part Series

The Work Letter (sometimes referred to as a 'Construction Agreement' or 'Work Agreement') is the portion of a lease, usually an exhibit, setting forth the provisions relating to the build-out of the tenant improvements to be made to the space leased. Often dealing with very large expenditures, the Work Letter is an extremely important part of the Lease. However, perhaps because of the varying types of build-outs, with differing parties responsible, it is a document that often breeds considerable confusion. This two-part article discusses the three common types of office space build-out arrangements to which landlords and tenants might agree, how they differ, and how those differences are to be addressed in drafting the Work Letter.

Landlord Performs Work at Own Expense: The 'Turn-Key' Build-Out

Whether because the landlord wishes to control all alterations made to its building, or the tenant wants cost certitude and minimum involvement in the build-out process, or both, on occasion the parties will agree to a 'turn-key' build-out, where the landlord constructs the build-out of the space at its sole cost and recovers that cost as a part of the rent over the initial term of the lease. A properly drafted 'turn-key' Work Letter (and the Lease of which it is part) must address the following matters:

1) Rent Commencement Date. The date on which rent starts to be payable is established as being not a specific date, but rather the date of substantial completion of the build-out (or earlier beneficial occupancy by the tenant). That is so because the landlord will control the progress of the build-out and the tenant will not want to be placed in the position of paying rent for space it cannot occupy. However, the tenant could delay substantial completion, whether as a result of change orders, long-lead items not available as needed to meet the landlord's construction schedule, tenant interference with landlord's contractor or subcontractors, or some other tenant-caused delay. Therefore, the lease should provide that in the event of such a delay caused by the tenant, the date of substantial completion will be deemed to be the date on which, but for the tenant delay(s), substantial completion of the build-out would have been attained. 'Substantial completion' is usually defined as being completion of the build-out except for normal 'punch list' items such as minor repairs, adjustments, and touch-ups, the making of which would not interfere with the tenant's beneficial occupancy and use of the premises. A careful tenant will also except from 'substantial completion' latent defects reported to the landlord within some specified period of time.

2) Plans and Specifications. Because the landlord is doing the turn-key build-out at its own expense and looking to recover the cost through rent, the plans and specifications for the build-out must obviously be fixed and costed before the lease is executed. If after lease execution the tenant requires changes to the plans and specifications and the landlord approves the changes, the lease should provide that the tenant bears any increase in cost occasioned by the changes and, as discussed above, such change orders will usually constitute a 'tenant delay.'

3) 'Base Building.' Because the build-out typically consists of improvements to space in a base building constructed or to be constructed by the landlord, it is important to define clearly what is included in the base building and consequently, what is to be included in the build-out work. The definition of 'base building' runs the gamut from a closed-in structure with neither heat nor light ('plain cold dark vanilla shell') to a building with mechanical, electrical, plumbing, and HVAC in place and, therefore, must be very carefully specified.

4) 'Building Standard.' Once the seam between base building and tenant improvements has been established, the next issue that must be addressed in a turn-key build-out is the quality of the materials and finishes to be used. Often the turn-key build-out will specify that the landlord is to use 'building standard' materials and finishes. Because the landlord is bearing the cost of the turn-key build-out and the tenant will be living with the results, it is obviously important for each to understand clearly what 'building standard' is for each material and finish. It is not unusual to have an exhaustive definition of 'building standard' attached as a schedule to the work letter, providing detailed specifications concerning such matters as partitions, flooring, ceiling, doors, frames and hardware, painting and wallcovering, millwork, light fixtures and switches, and life safety and mechanical systems.

5) Milestones. In the case of a building under construction, a tenant concerned about the landlord's adherence to the construction schedule may wish to require that certain specific construction milestones (e.g., existing building demolished, foundation poured, etc.) be agreed to and set forth in the Work Letter. If these milestones are not met, that failure can trigger either an abatement of rent (X days rent for each day of delay) or, in certain extreme cases, an option for the tenant to terminate the lease.

6) Restoration. Generally speaking, tenants are not required to remove the build-out construction (as opposed to subsequent alterations). Nevertheless, some landlords require that portions of the work that the landlord reasonably determines are specialized to the tenant's use of the premises be removed by the tenant at the end of the lease term at the tenant's expense. Interior staircases and raised computer room flooring are examples of such specialized improvements. Whether that determination by the landlord is to be made at the end of the lease term or at the time the plans are approved is often a bone of contention.

Next month's installment will address Work Letters in which the work is done at the tenant's expense by either the tenant or the landlord.

Myles Hannan, a member of this newsletter's Board of Editors, is a partner with Linowes and Blocher LLP (www.linowes-law.com), located in Bethesda, MD.