Work Letter 'What Ifs': Practical Solutions to Possible Problems

Prior to executing the lease and as part of tenant's due diligence of the premises, the tenant should confirm that the building, and also the larger shopping center or business complex in which the building is located (if any), satisfy all of the requirements necessary for the tenant to conduct its business at the premises. The tenant's due diligence of the base building centers around whether the base building improvements — specifically, the building's structure, common areas and mechanical, electrical and plumbing systems (all of which are typically the improvements for which the landlord bears maintenance, repair and replacement responsibility under the lease) — would support the tenant's desired improvements in, and intended use of, the premises.

To confirm that the tenant gets the benefit of its bargain, that tenant must first understand what is included in the base building and also what improvements, if any, need to be made to enable the tenant's requirements (including its furniture, fixtures and equipment) to be constructed and installed in the premises.

The Work Letter should specifically describe the base building plans and specifications by reference, and expressly require the landlord to complete all such base building work in accordance with those plans and specifications at the landlord's sole cost (and not from any tenant improvement allowance provided by the landlord, as discussed below). Schematic drawings and specifications of the base building materials and finishes should be attached as exhibits to the lease, but only after the tenant has reviewed and approved them (even if the tenant's approval is not formally required). If the plans and specifications for the base building are not complete at the time the lease is signed, the Work Letter should include a detailed description of the components of the base building to be constructed. The Work Letter should also set forth all relevant milestones and deadlines by which such work must be completed (and also the tenant's rights and remedies, such as rent abatement, in the event those deadlines are missed).

When reviewing the base building plans and specification, the tenant should consider, among other things: a) the electrical service to the premises (specify watts per usable square foot required); b) air conditioning into the premises; c) water and sewer services; d) the condition of all restrooms and stairwells (to the extent located outside the premises and shared with other tenants of the building); e) whether the fire sprinkler system is ready for expansion into the premises; f) whether life safety systems are in place; g) whether building elevators are fully operable; h) if the building is multi-tenant, whether the elevator lobby on the main floor is fully finished and the elevator lobby on tenant's floors are in condition ready for the tenant's finish work; and i) if the building is newly constructed, whether the building has been completed in accordance with the applicable shell construction documents.

To perform this due diligence, the tenant should consider engaging an architect to inspect the building and review the shell building plans and specifications of the building supplied by landlord. The building shell definition is a critical economic component of the lease transaction, and a prudent tenant will want that definition (and all other Work Letter provisions) reviewed by someone with expertise.

Also, if the tenant is preparing its plans for its improvements concurrently with the landlord's preparation of the base building plans, the tenant must be kept informed of any changes to the base building plans that will affect the premises. In addition, the tenant may want the right to provide input on the details of the design and selection of materials for the base building. However, the landlord will want to make all final decisions as to all drawings and specifications for the building.

If any base building improvements are planned or otherwise required to be installed in the building, then the Work Letter should: a) as discussed above, contain an exhibit specifying in sufficient detail all base building work to be completed by the landlord; b) require the landlord to complete all base building work at its sole cost and expense (and not deducted from any tenant improvement allowance); and c) require that all base building work be completed in order to achieve “substantial completion” (as further discussed herein) as a condition to commencement of the term of the lease and of the tenant's payment obligations under the lease. In the Work Letter, the landlord must expressly represent and warrant that the base building improvements, once completed, will comply with all applicable governmental requirements, and be free and clear of all defects in design, materials and workmanship. In the lease provisions governing the tenant's obligation to reimburse the landlord for operating expenses (if applicable), the tenant should exclude all costs and expenses required by the landlord to satisfy such representations and warranties, and expressly provide that the landlord is liable for all such costs and expenses without reimbursement from the tenant.

If the landlord is providing a tenant improvement allowance to pay for all or any portion of the tenant improvements, the tenant should ensure that none of the allowance is used for the payment of costs associated with the landlord's base building work.

The landlord should limit its obligation to undertake base building improvements as much as possible, and will typically reserve any such obligation only to its major tenants of the building. First, the landlord should ensure that the base building improvements that are required by the tenant do not exceed that which is typical for the type of building and the use of the premises permitted by the landlord. For example, a landlord may construct an office building to permit normal office use; if a tenant's electrical requirements exceed normal office use, then the tenant should be required to improve the building's systems to accommodate these excess requirements (provided that the landlord approves such excess usage). If base building improvements are required, however, a landlord will want the Work Letter to expressly limit its obligation to only those improvements specifically required in the letter.

If the landlord agrees to represent and warrant compliance of base building improvements with applicable law, the landlord should expressly exclude any defects arising from the tenant's design and materials, with the tenant assuming sole responsibility for correcting any such defects at its sole cost. If the landlord agrees to warranty the base building work, the warranty should extend only for a period of time corresponding to the length of the warranties received by the landlord from its contractor.

Finally, the landlord requires the right to complete the base building requirements without any interference or delay by the tenant. If the landlord permits the tenant to access the premises prior to the commencement date in order for the tenant to install its furniture, fixtures and equipment, the landlord should ensure that the tenant coordinates its work with the landlord's work. To facilitate communication, each party should designate an agent who will serve as such party's point-of-contact (by telephone or email) regarding Work Letter matters (including coordination of work). The landlord should also require that the Work Letter provide that any delay attributable to the tenant's acts or omissions will extend the landlord's performance deadlines — for example, any deadline to achieve substantial completion — on a day-for-day basis.

2. What if the Landlord Fails to Complete Base Building Work or Tenant Improvements According to Schedule?

The tenant will be motivated to have any base building work and tenant improvements completed as soon as possible, in order to avoid a holdover situation at its existing premises (if any) and to open for business in the premises. If the landlord is responsible for completing any work, the Work Letter should provide the tenant with remedies in the event performance deadlines are missed.

A typical milestone for completion of tenant improvements in multi-tenant buildings is the “substantial completion date.” The term “substantial completion” can be defined in various ways, but usually requires completion of the work substantially in accordance with the construction documents (as modified by change orders), as certified by the architect, subject to punch-list items, which will not unreasonably interfere with the tenant's ability to use the premises for the permitted use. The tenant should require the Work Letter to state an outside date by which substantial completion will occur. If that date is missed, then the tenant will want rent to abate on a day-for-day basis for each day beyond the outside substantial completion date until substantial completion is achieved. The tenant may also want the ability to terminate the lease if substantial completion does not occur by the defined outside date or some extension thereof.

As another remedy, the tenant may want the right (but not the obligation) to exercise self-help to complete the landlord's work and to seek reimbursement of all costs incurred to complete such work (or deduct the costs incurred by the tenant from base rent and additional rent becoming due under the lease). To exercise self-help rights, the tenant must require the landlord to assign to it all of the landlord's rights (but not the obligations, for which landlord should remain solely responsible) under the applicable construction contracts to which the landlord (or its affiliate) is a party.

In the landlord's view, the tenant's right to exercise self-help and complete construction of any of the landlord's work (including tenant improvements) should be conditioned upon: a) the tenant performing the work in a manner that does not unreasonable affect (or materially adversely affect) other building tenants or the services provided to those tenants; b) the tenant not preventing or materially interfering with access to and from the premises (or building or larger commercial center in which the premises is located); c) the tenant not adversely affecting the structural integrity of the building or the operation or capacity of the building systems; and d) the tenant not entering into the premises of other tenants without those tenants' prior written consent.

If the tenant is relocating its premises, it must have the right to recover holdover rent and other damages it incurs under its existing lease if the landlord fails to substantially complete its work and deliver the premises by the scheduled completion date. In addition, the tenant should require the landlord to provide an indemnity protecting the tenant from all damage, claims and liability arising from the landlord's failure to timely deliver the premises to the tenant.

If it agrees to any remedies, the landlord should ensure any deadline is subject to extension for tenant delay and force majeure. Tenant delay should include that caused by any change order; any failure by the tenant to timely respond to any request for its approval required under the lease (for example, the tenant may have the right to approve pricing estimates, the final cost budget, and change orders); any failure by the tenant to pay amounts required for the work; any delay caused by activities of the tenant and its agents, employees, and contractors in the premises, building or center; and any breach or event of default by the tenant under the lease. The tenant should also be responsible for all reasonable costs and expenses incurred by the landlord caused by any tenant delay, and should waive all remedies (including any right to damages) against the landlord arising from any such tenant delay.

Furthermore, if the milestone date (e.g., substantial completion date) is delayed by reason of any tenant delay, the lease should provide that the date of substantial completion is nevertheless deemed to have occurred as of the date on which substantial completion would have occurred but for any such tenant delay, and the commencement date and rent commencement date should be determined as if substantial completion occurred on such earlier date. If the Work Letter provides for extensions to the landlord's performance deadlines by reason of delays attributable to the tenant or its contractors, the tenant should require the landlord to provide written notice of such delay as a condition to any such extension. The landlord's performance deadlines (and also the tenant's) should also be subject to extensions for force majeure delays, although the tenant should require receipt of written notice from the landlord of such force majeure and anticipated delay resulting therefrom.

Next month, we will look at four more “what-if” scenarios that landlords and tenants should consider when negotiating Work Letters.

***** Melissa Vandewater is a partner in the Real Estate Practice Group of Seyfarth Shaw LLP and is admitted to practice in Illinois and Arizona. Her practice concentrates primarily on the acquisition, development, financing, leasing and disposition of commercial real estate. She can be reached at (312) 460-5563 or [email protected].