Turnkey Build-Outs

Timing

A turnkey premises is built for a specific tenant's operation; therefore, the work is heavily reliant upon the landlord's receipt of the tenant's plans and specifications. If the tenant has not submitted plans and specifications to the landlord prior to lease execution, then the work letter should contain specific time-frames for plan submission and responses, as well as a time-line for completion of the work itself. The work letter should specifically define what tenant actions (or inactions) constitute a tenant delay, and what remedies accrue to the landlord in such events. The parties should consider including the following actions or inactions as tenant delay: 1) late submission of the tenant's plans and specifications; 2) failure by the tenant to respond to information requests from the landlord; 3) changes to the scope of work after plans have been approved by the landlord; and 4) the requirement that landlord use materials that may require longer lead times for delivery (the work letter should address a process for approval and substitution of materials when specific materials requested by the tenant are not available).

Likewise, the tenant has concerns about delay in delivery when it is not in control of the build-out. The tenant may need to vacate an existing space by a specific date or the store may have been slotted to be opened within a particular fiscal year to satisfy financing or corporate requirements.

The work letter should articulate the consequences for a delay by either party. If there is a tenant delay, the landlord should seek the right to: 1) assume a particular response or have the right not to include such item in the landlord's work; 2) accelerate the rent start date by one day for each day of delay; and 3) obtain a day-for-day extension of the outside delivery date. For the landlord's delay in delivery, the tenant should seek to protect itself with an outside delivery date which would give it the right to accrue liquidated damages or afford the tenant a termination right.

Whether addressing a tenant or landlord delay, the work letter should delineate time periods during which such delay may be claimed, or a cure period before the delay accrues. It should also discuss an aggregation of delays or, when there are delays by both parties, an off-setting of delays.

For delays that are entirely out of a party's control, the work letter (or the lease provisions) should contain a force majeure clause. This provision should define the specific events that constitute an event of force majeure, and provide that any outside delivery date will be extended by the number of days of the force majeure delay.

Costs

The preparation of plans and specifications requires an expenditure of money that most parties are not willing to incur until they have an executed lease. It is unlikely that a full set of plans and specifications will be prepared prior to lease execution; therefore the parties should develop a lease outline drawing (“LOD”), identifying the existing or proffered conditions, and a clear and detailed description of the scope of the work to be performed. Agreeing to these two items before execution allows the landlord to assess the overall economic feasibility of the project, and to develop a preliminary budget from which rent can be determined. If the work is not accurately priced, the landlord runs the risk of not only being responsible for the immediate cost overruns, but also not being able to fully recover its investment over the term of the lease.

The detailed description of the work helps to mitigate the risk of ambiguity as to the quality and types of materials to be used in the construction. If there are gaps or holes in specificity, or the LOD is unclear, it could result in unanticipated costs in construction. For example, a tenant's turnkey work letter may provide for “tenant's standard countertops” or “countertops to be determined or approved by the tenant.” Without further detail, the landlord may have priced laminate countertops as compared to granite countertops. Thus, the work letter should clearly address the parties' expectation as to the materials and finishes to be used and the process for resolving ambiguities to protect the landlord's costs.

While previously discussed with regard to timing, change orders can also significantly increase the cost of the turnkey build-out. From the tenant's perspective, the unique design and build-out of the store is one of the tenant's business's most important attributes, and corporate directives regarding these items can change significantly from time to time. Since the tenant needs the flexibility to request changes in the scope of the work, the tenant would want the work letter to articulate a procedure whereby the landlord notifies the tenant of the cost associated with the change order and gives the tenant the opportunity to either confirm the change order (thereby agreeing to be responsible for increased costs and the impact of delay) or to rescind its request for the change order. Some landlords may negotiate an aggregate bust number pursuant to which the landlord has the ability to terminate the lease if the work exceeds a specific dollar figure or is extensively delayed. The tenant will want the right to negate the termination by agreeing to be responsible for the overage and delay.

Delivery

In addition to timing and cost issues, the work letter should detail what constitutes completion and delivery of the Premises. The landlord may expect to deliver the premises to the tenant in a substantially complete condition, whereby the work is substantially complete, but for minor issues which do not affect the tenant's work or operation of the tenant's business (such as those repairs which can be performed simultaneously with the tenant's completion of the tenant's work). The tenant, on the other hand, would prefer to begin paying rent only after actual completion of the project and issuance of a certificate of occupancy or its jurisdictional equivalent, thereby avoiding dark rent. The work letter should specifically address the standard for delivery and the process for evaluating the work and completion of minor items post-delivery.

The landlord should seek to outline a process for the tenant to inspect the work and deliver a punch list to the landlord identifying any particular issues related to the turnkey. This would allow the time period for rent commencement to begin, while permitting the landlord to make any minor, final repairs after it delivers the space to the tenant. The landlord should require the tenant's inspection to be completed within a short period of time after the landlord's delivery of the premises to the tenant, but prior to the tenant's installation of any additional furniture, fixtures or equipment. Once the tenant has begun its fixturing or opened for business, the tenant should be deemed to have accepted the landlord's work as complete.

Because the inspection and punch list items are determined prior to the tenant's opening for business, the parties may not know which items, if any, truly affect the operation of the tenant's business or issuance of the certificate of occupancy until a party seeks to obtain the certificate of occupancy. Indeed, in some jurisdictions the certificate of occupancy will not be issued until the tenant has stocked and fixtured the store. In those jurisdictions, the certificate of occupancy should not be part of the landlord's obligations. For this reason, the tenant will want to identify a process for addressing latent defects in the premises which do not become apparent during the punch list timing window, and the landlord will want to make sure that no unexpected issues affect the original delivery date. It is reasonable to toll the fixturing period for the rent start date or allow the accrual of liquidated damages until the resolution of such unexpected issue; however, any such delay caused by such unexpected or latent items should not affect the original delivery date thereby potentially triggering retroactive penalties or termination rights.

Waivers, Warranties and Indemnity

Most landlord form leases provide that the tenant waives all claims against the landlord. In the event of defective construction or design of the turnkey, which results in injury to the tenant, its employees or customers, or the tenant's business, the tenant will likely still want to look to the landlord for recovery. Since waivers and indemnifications are typically addressed in the lease itself, rather than the work letter, these issues can be overlooked. From the landlord's perspective, the landlord does not want open ended liability to the tenant. It is best to limit the scope of the landlord's liability for such defects either by warranting the landlord's work for a limited period of time or by agreeing to pass through all warranties to the tenant, or to enforce the warranties on the tenant's behalf. Specifically, the tenant would at least want the landlord to provide warranties that the tenant would be able to get if the tenant had performed the work itself, such as for the HVAC and other mechanical, plumbing and electrical systems.

While there are many other issues to consider with a turnkey build-out, when attaching the work letter to the lease, the drafter should consider these issues rather than simply deferring them to the construction personnel. Leaving these issues to be determined in the field can lead to potential delays in completion of the turnkey build-out and increased costs for both the landlord and the tenant.

Kristen N. Wilson ([email protected]) is an attorney at the law firm of Hirschel Savitz Parker & Hollman P.C. in Gaithersburg, MD, where she primarily represents landlords and developers in the leasing of strip centers and mixed-use projects.