In the Spotlight: Considerations for Payment of a Construction Allowance

Typically, a tenant will request that payment of a construction allowance be made over time, by way of progress payments, as the tenant performs its construction of the premises. In contrast, the landlord would like to retain the construction allowance as long as possible, so as to assure that the premises are properly constructed, with all 'punch-list' items completed, that the tenant has opened for business, and that all required documentation has been provided to the landlord. Often, a compromise is struck, so that a portion of the construction allowance, sometimes as much as one-half, is paid to the tenant during the course of the tenant's performance of its construction obligations (provided that the required documentation has been furnished to the landlord), with the remaining portion of the construction allowance being paid to the tenant once the construction is completed, tenant has opened for business in the premises, and all documentation has been furnished to the landlord. [See Sample Clause below.]

The landlord should be certain that a substantial portion of the construction allowance is not paid to the tenant upfront, so that the landlord can ensure that the premises are properly constructed and that the tenant has sufficient funds remaining in order to complete the construction process. While the manner and timing for payment of the construction allowance will vary from deal to deal, generally no more that one-half should be paid to the tenant prior to the completion of all of the tenant's construction work.

Documentation for Payment of The Construction Allowance

Regardless of the manner and timing of the payments of the construction allowance, no payment should be made to the tenant for any portion of the construction allowance unless the tenant provides the landlord with the proper documentation. At a minimum, the landlord should receive from the tenant a contractor's statement, which identifies the general contractor, all subcontractors, and all materialmen that furnished labor or materials toward the performance of the tenant's construction work. Further, concurrently with the submission by the tenant for the requested draw from the construction allowance, partial lien waivers at least equal to the amount of the draw request should be furnished to the landlord; these lien waivers should coincide with those amounts shown on the contractor's statement. In addition, there should be a statement issued by the architect that identifies the portion of the construction that has been completed by the tenant at the time of the draw request. Generally, the portion of the construction work that has been completed by the tenant should be in the same proportion as (or more than) the draw request relates to the total construction allowance.

Once all the tenant's construction work is completed, the tenant should be permitted to make its final draw request for the balance of the construction allowance. However, final documentation needs to be furnished by the tenant before the landlord should be obligated to make the final payment under the construction allowance. In particular, the tenant should be required to furnish the following documentation:

1) A final contractor's statement identifying the general contractor, all subcontractors, and all materialmen involved in the performance of the tenant's construction work;

2) Final waivers of lien from the general contractor, all subcontractors, and the materialmen who have furnished labor or materials in connection with the tenant's construction work. Often there is a de minimus standard established between the landlord and the tenant, whereby contractors, subcontractors, and materialmen that furnish less than a minimal amount of work or materials for the performance of tenant's construction work (e.g., less than $2,000) do not need to provide lien waivers, but this de minimus standard will vary with the strength of the tenant and the amount of the construction allowance;

3) A warranty issued by the general contractor in favor of the tenant and the landlord, which warranties all construction work against defect in labor or materials for a period of one year from the completion of construction;

4) A set of final 'as-built' plans, identifying all differences from the actual construction work performed by the tenant as compared with that construction work identified on the tenant's plans and specifications; and

5) An estoppel certificate identifying the material terms and provisions of the lease. This estoppel certificate is especially important if the construction allowance is being funded by a loan that is being provided by the landlord's lender.

Once all documentation has been provided to the landlord in acceptable form, the balance of the construction allowance should be tendered to the tenant. As a precondition for funding of the construction allowance, all the tenant's work, including all punch-list items, should be completed; the tenant should have furnished the landlord with a Certificate of Occupancy for the premises, and the tenant should have opened for business in the premises.

Payback of the Construction Allowance

To the extent that the amount of the construction allowance has not been incorporated into the amount of rent being paid by the tenant, there should be a provision in the lease which provides that the tenant will be obligated to repay the unamortized portion of the construction allowance, in the event of a default by the tenant and the termination of the lease by the landlord. In the event that the construction allowance has been incorporated into the rent, then the default provisions of the lease typically will provide that all future rent (or at least the present value thereof), will be payable by the tenant as a calculation of a portion of the landlord's damages for the tenant's default. As a result, it is not necessary to provide separately for such amount in the construction allowance provision.

However, to the extent that the construction allowance has not been incorporated into the rent, in order to make the landlord whole following the tenant's default, the construction allowance provision should provide for a repayment of the unamortized portion of the construction allowance. The amortization of the construction allowance should be calculated on a straight-line basis over the term of the lease.

Conclusion

By carefully documenting the manner in which the construction allowance is to be paid, the documentation that is required, and the means by which the construction allowance should be repaid in the event of a default by the tenant, the landlord can protect itself from making a payment of the construction allowance to the tenant without receiving the benefit of its bargain from the tenant, without risking mechanic liens or other duplicate payment of the amounts that are to be covered by the construction allowance, and without encountering costly litigation to receive its bargained-for consideration for paying the construction allowance.

Sample Clause

Landlord agrees to pay Tenant, if Tenant is not then in default, the cost of Tenant's Work up to the aggregate sum of $___ ('Construction Allowance'), but not more than that amount, within thirty (30) days following the fulfillment of all of the following requirements:

1. Completion of Tenant's Work in accordance with Tenant's plans, as approved by Landlord, lien free and in a manner satisfactory to Landlord and Landlord's architect;

2. Presentation to Landlord, in form and detail satisfactory to Landlord, of:

a. Contractor's Sworn Statement showing that the amount requested by Tenant has been spent by Tenant on the construction of the Premises and listing all subcontractors and material suppliers and amounts which they were to be paid and were paid for work performed for or on the Premises or for materials supplied for Tenant's Work;

b. Contractor's Original and Notarized, Unconditional Final Waiver of Lien; and

c. Notarized Final Waivers of Lien from all subcontractors and material suppliers for goods and services.

3. Presentation to Landlord of unconditional Certificate of Occupancy from all applicable governmental authorities for occupancy of the Premises;

4. Tenant shall have opened its store in the Premises for business and shall have commenced the payment of Minimum Annual Rental and all other rents and charges under this Lease.

5. An architect's certification that the Premises have been constructed in accordance with Tenant's plans, as approved by Landlord, in writing, and are one hundred percent (100%) completed in accordance with such plans; and

6. One (1) reproducible set of 'as-built' drawings of the Premises has been delivered to Landlord.

Landlord shall be entitled to withhold from the Construction Allowance any unpaid portion of the amount at issue in the event of a default by Tenant, even if Tenant shall have paid all or a portion of the cost of Tenant's Work. The cost of any additional work performed by Landlord for the benefit of Tenant shall be deducted from the Construction Allowance before said Construction Allowance is paid to Tenant. In no event shall the Construction Allowance exceed the actual cost of Tenant's Work.

Glenn A. Browne is a shareholder in the law firm Braun, Browne
& Associates, P.C., located in Riverwoods, IL. His law practice is concentrated in the areas of purchase and sale of real estate, commercial leasing, and lease-related matters.

In the course of negotiating a retail lease, landlords are often requested by tenants to pay a portion of the tenant's cost of construction of the premises. The manner in which the landlord would make such a payment is commonly called a 'construction allowance,' whereby a portion of the tenant's construction cost is defrayed by a payment made by the landlord, which payment may or may not be incorporated into the rental structure that will then be owed by the tenant during the term of the lease.

Several issues arise when contemplating the payment of a construction allowance to the tenant. In particular, issues such as the manner and timing for payment of the construction allowance, documentation required for the payment, and repayment in the event of a default by the tenant, should all be considered when addressing the issue of the construction allowance in the lease. This article discusses the foregoing issues and addresses various manners in which these issues can be dealt with in the lease.

Manner and Timing of Payment

Typically, a tenant will request that payment of a construction allowance be made over time, by way of progress payments, as the tenant performs its construction of the premises. In contrast, the landlord would like to retain the construction allowance as long as possible, so as to assure that the premises are properly constructed, with all 'punch-list' items completed, that the tenant has opened for business, and that all required documentation has been provided to the landlord. Often, a compromise is struck, so that a portion of the construction allowance, sometimes as much as one-half, is paid to the tenant during the course of the tenant's performance of its construction obligations (provided that the required documentation has been furnished to the landlord), with the remaining portion of the construction allowance being paid to the tenant once the construction is completed, tenant has opened for business in the premises, and all documentation has been furnished to the landlord. [See Sample Clause below.]

The landlord should be certain that a substantial portion of the construction allowance is not paid to the tenant upfront, so that the landlord can ensure that the premises are properly constructed and that the tenant has sufficient funds remaining in order to complete the construction process. While the manner and timing for payment of the construction allowance will vary from deal to deal, generally no more that one-half should be paid to the tenant prior to the completion of all of the tenant's construction work.

Documentation for Payment of The Construction Allowance

Regardless of the manner and timing of the payments of the construction allowance, no payment should be made to the tenant for any portion of the construction allowance unless the tenant provides the landlord with the proper documentation. At a minimum, the landlord should receive from the tenant a contractor's statement, which identifies the general contractor, all subcontractors, and all materialmen that furnished labor or materials toward the performance of the tenant's construction work. Further, concurrently with the submission by the tenant for the requested draw from the construction allowance, partial lien waivers at least equal to the amount of the draw request should be furnished to the landlord; these lien waivers should coincide with those amounts shown on the contractor's statement. In addition, there should be a statement issued by the architect that identifies the portion of the construction that has been completed by the tenant at the time of the draw request. Generally, the portion of the construction work that has been completed by the tenant should be in the same proportion as (or more than) the draw request relates to the total construction allowance.

Once all the tenant's construction work is completed, the tenant should be permitted to make its final draw request for the balance of the construction allowance. However, final documentation needs to be furnished by the tenant before the landlord should be obligated to make the final payment under the construction allowance. In particular, the tenant should be required to furnish the following documentation:

1) A final contractor's statement identifying the general contractor, all subcontractors, and all materialmen involved in the performance of the tenant's construction work;

2) Final waivers of lien from the general contractor, all subcontractors, and the materialmen who have furnished labor or materials in connection with the tenant's construction work. Often there is a de minimus standard established between the landlord and the tenant, whereby contractors, subcontractors, and materialmen that furnish less than a minimal amount of work or materials for the performance of tenant's construction work (e.g., less than $2,000) do not need to provide lien waivers, but this de minimus standard will vary with the strength of the tenant and the amount of the construction allowance;

3) A warranty issued by the general contractor in favor of the tenant and the landlord, which warranties all construction work against defect in labor or materials for a period of one year from the completion of construction;

4) A set of final 'as-built' plans, identifying all differences from the actual construction work performed by the tenant as compared with that construction work identified on the tenant's plans and specifications; and

5) An estoppel certificate identifying the material terms and provisions of the lease. This estoppel certificate is especially important if the construction allowance is being funded by a loan that is being provided by the landlord's lender.

Once all documentation has been provided to the landlord in acceptable form, the balance of the construction allowance should be tendered to the tenant. As a precondition for funding of the construction allowance, all the tenant's work, including all punch-list items, should be completed; the tenant should have furnished the landlord with a Certificate of Occupancy for the premises, and the tenant should have opened for business in the premises.

Payback of the Construction Allowance

To the extent that the amount of the construction allowance has not been incorporated into the amount of rent being paid by the tenant, there should be a provision in the lease which provides that the tenant will be obligated to repay the unamortized portion of the construction allowance, in the event of a default by the tenant and the termination of the lease by the landlord. In the event that the construction allowance has been incorporated into the rent, then the default provisions of the lease typically will provide that all future rent (or at least the present value thereof), will be payable by the tenant as a calculation of a portion of the landlord's damages for the tenant's default. As a result, it is not necessary to provide separately for such amount in the construction allowance provision.

However, to the extent that the construction allowance has not been incorporated into the rent, in order to make the landlord whole following the tenant's default, the construction allowance provision should provide for a repayment of the unamortized portion of the construction allowance. The amortization of the construction allowance should be calculated on a straight-line basis over the term of the lease.

Conclusion

By carefully documenting the manner in which the construction allowance is to be paid, the documentation that is required, and the means by which the construction allowance should be repaid in the event of a default by the tenant, the landlord can protect itself from making a payment of the construction allowance to the tenant without receiving the benefit of its bargain from the tenant, without risking mechanic liens or other duplicate payment of the amounts that are to be covered by the construction allowance, and without encountering costly litigation to receive its bargained-for consideration for paying the construction allowance.

Sample Clause

Landlord agrees to pay Tenant, if Tenant is not then in default, the cost of Tenant's Work up to the aggregate sum of $___ ('Construction Allowance'), but not more than that amount, within thirty (30) days following the fulfillment of all of the following requirements:

1. Completion of Tenant's Work in accordance with Tenant's plans, as approved by Landlord, lien free and in a manner satisfactory to Landlord and Landlord's architect;

2. Presentation to Landlord, in form and detail satisfactory to Landlord, of:

a. Contractor's Sworn Statement showing that the amount requested by Tenant has been spent by Tenant on the construction of the Premises and listing all subcontractors and material suppliers and amounts which they were to be paid and were paid for work performed for or on the Premises or for materials supplied for Tenant's Work;

b. Contractor's Original and Notarized, Unconditional Final Waiver of Lien; and

c. Notarized Final Waivers of Lien from all subcontractors and material suppliers for goods and services.

3. Presentation to Landlord of unconditional Certificate of Occupancy from all applicable governmental authorities for occupancy of the Premises;

4. Tenant shall have opened its store in the Premises for business and shall have commenced the payment of Minimum Annual Rental and all other rents and charges under this Lease.

5. An architect's certification that the Premises have been constructed in accordance with Tenant's plans, as approved by Landlord, in writing, and are one hundred percent (100%) completed in accordance with such plans; and

6. One (1) reproducible set of 'as-built' drawings of the Premises has been delivered to Landlord.

Landlord shall be entitled to withhold from the Construction Allowance any unpaid portion of the amount at issue in the event of a default by Tenant, even if Tenant shall have paid all or a portion of the cost of Tenant's Work. The cost of any additional work performed by Landlord for the benefit of Tenant shall be deducted from the Construction Allowance before said Construction Allowance is paid to Tenant. In no event shall the Construction Allowance exceed the actual cost of Tenant's Work.

Glenn A. Browne is a shareholder in the law firm Braun, Browne
& Associates, P.C., located in Riverwoods, IL. His law practice is concentrated in the areas of purchase and sale of real estate, commercial leasing, and lease-related matters.