Commercial Real Estate Leases Part 2

Posted by: on Wed, Apr 27, 2016

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National Business Institute: Commercial Lease Seminar

Presented by D. Christ Albright, Esq.

A. TURNKEY (LANDLORD BUILD) v. TI ALLOWANCE (TENANT BUILD).

TURNKEY CLAUSE EXAMPLE (Landlord build)

All the Tenant Improvements described above, if any, shall be performed by Landlord at its cost and expense using Building standard materials and finishes and in the Building standard manner. All other work and upgrades, subject to Landlord’s approval, shall be at Tenant’s sole cost and expense, plus any applicable state sales or use tax thereon, payable upon demand as additional rent. Tenant shall be responsible for any delay in the completion of the Tenant Improvements resulting from any such other work and upgrades requested or performed by Tenant. Landlord shall enter into a direct contract for the Tenant Improvements with a general contractor selected by Landlord. In addition, Landlord shall have the right to select and/or approve of any subcontractors used in connection with the Tenant Improvements.

Landlord shall deliver the Premises to Tenant with the Tenant Improvements Substantially Complete. The Tenant Improvements shall be deemed to be “Substantially Complete” on the date that all Tenant Improvements have been performed, other than any details of construction, mechanical adjustment or any other similar matter, the non-completion of which does not materially interfere with Tenant’s use of the Premises. However, the parties hereby agree that if Landlord is delayed in the performance of the Tenant Improvements as a result of any act or omission of Tenant or any Tenant Entity (a “Tenant Delay”), including without limitation a delay as a result of (a) Tenant’s failure to agree to plans and specifications and/or construction cost estimates or bids, (b) Tenant’s request for materials, finishes or installations with long lead times, (c) Tenant’s change in any plans or specifications, or (d) performance or completion by a party employed by Tenant, then the Tenant Improvements shall be deemed to be Substantially Complete on the date that Landlord could reasonably have been expected to Substantially Complete the Tenant Improvements absent any Tenant Delay and such date shall be deemed to be the actual Commencement Date of the Lease.

TENANT ALLOWANCE CLAUSE EXAMPLE (Tenant Build)

Tenant shall be solely responsible for completing all of the interior tenant improvements together with exterior signage and constructing the same in accordance with the plans and specifications to be approved by both Tenant and Landlord as set forth in Section ___ of the Lease. Tenant’s responsibility shall include Tenant choosing and retaining a suitable general contractor and/or construction manager and other professionals as needed, together with any other direct contractors who will be retained by Tenant directly, if any, for any portion of the work not to be completed by a subcontractor to a retained general contractor. Tenant shall be solely responsible to select suitable professionals and contractors for the quality of whose work Tenant shall remain responsible hereafter, subject however to the following conditions: All contractors retained by Tenant must be properly licensed by the State Contractor’s Board; the name of any contractor or construction manager to be retained by Tenant shall be provided to Landlord at least five (5) days prior to executing an agreement retaining such professional, and Landlord, in its commercially reasonable discretion, may object to any contractor and require Tenant to choose an alternative contractor, upon commercially reasonable grounds shown. Tenant shall be responsible to complete the Tenant Improvements and pay for the same on a timely, lien-free basis and is responsible to pay for all of the Tenant Improvement costs and expenses through its own resources, provided, however, that Landlord shall contribute for the benefit of Tenant an allowance of Fifty-Five and 00/100 Dollars ($55.00) per usable square footage (calculated as set forth in Section ___ of the Lease) of the Premises (the “Tenant Improvement Allowance”) to be paid towards the Leasehold Improvement Costs. The Tenant Improvement Allowance shall be disbursed in the manner described in Paragraph ____, below, and shall be used solely to assist Tenant in the payment of the Tenant Improvement Costs. All items of Leasehold Improvements, whether or not the cost thereof is covered by the Tenant Improvement Allowance, shall become the property of Landlord upon their installation in the Premises and shall remain on the Premises at all times during and upon expiration of the Term, solely excepting any personal property of Tenant such as furniture, specialized trade fixtures unique to Tenant’s business, or readily movable equipment which has not become affixed to the Premises in a manner so as to be incorporated into the real property of the Premises as an improvement thereupon.

Frequently Asked Questions

What is the Difference between a Turnkey Build and a Tenant Build?

In a turn-key work letter, the parties approve the plans for the TI buildout of the tenant’s premises before the lease is signed and the landlord agrees to pay for the completion in conformance with the plans at its own cost. The danger to the landlord of such a lease is that it is accepting the risk of cost overruns (although if those are due to tenant requested change orders the tenant would bear that cost). The danger to the tenant being that the landlord may seek to control such costs via the use of lower quality construction and materials than tenant would have utilized had it been in control. The tenant’s lease term will typically commence upon the premises becoming available to the tenant, for its turnkey entry and use. The real question thus centers on control of the process. If the tenant is more concerned with controlling the process than with the convenience of not being directly involved in hiring contractors and overseeing the buildout on its own, then a TI Allowance lease should be used instead.

In a tenant improvement allowance work letter the lease determines the amount, per square footage, that the landlord will provide to the tenant for a buildout allowance, the tenant is responsible to hire its own contractor and to build out the space at that cost (plus whatever additional costs tenant is willing to bear and contribute), and to do so on time. Tenant has greater control under this approach but also greater responsibility for timely performance, as lease will typically commence within set time period after keys are provided in order for tenant to complete its work. Thus, tenant may find itself paying rent before it has opened for business.

What are the advantages/disadvantages to the Tenant and to the Landlord of Turnkey vs. Tenant Build? The main issues revolve around control of the process and which side bears the risk of late delivery, and the nature of that risk.

B. NEGOTIATING ALLOWANCE AMOUNTS, USES, AND OVERRUN CONTINGENCIES

Landlord positions: Landlords typically view a TI allowance as a concession to the tenant, and take a conservative view as to whether the tenant will stay and not breach long enough for these moneys to be reacquired over a full amortization period. Based thereon, they will argue that TI allowance, especially any requested increase in TI allowances, are a concession to the tenant and that the landlord should therefore be allowed to direct and limit the uses of these allowances in certain respects. For example, landlords may wish to use the allowance, first, for the construction of improvements that will stay with the premises or otherwise increase the long term value even after tenant leaves, including for generic improvements and general trade fixtures or other elements that are not so unique to the tenant that they would be unable to be re-used upon tenant abandonment or eviction and reletting. To the extent landlord loses control over the process, in a tenant build-out, it may wish to regain some control by approving change orders, vetoing certain contractors, etc. If extra allowance remains unused at the end of the ti build-out, this may have tax consequences and the landlord should consult with a tax attorney or CPA before agreeing to any particular application of the excess with the tenant.

Tenant positions: The tenant will view the landlord as recovering the TI allowance over time through rental payments amortized to reacquire the funds provided. Thus, tenants will argue they have the right and should be allowed to use the TI moneys as they see fit, as they will in essence be paying them back. If the tenant is required instead to only use the funds in certain ways, it may wish to negotiate a rental reduction as to any unused allowance or to be allowed to apply the allowance towards its other move-in costs, or to pre-paying certain initial rent payments.

C. SCOPE OF WORK

Even in a tenant build out, the Landlord is typically responsible to deliver the building surrounding the premises, i.e., the base, shell, and core of the premises in a condition that reflects the market for “base building delivery” which would include demolishing any previous tenant improvements, but leaving certain HVAC systems and conduits and utility wiring in place.

D. DEFINING ESSENTIAL TERMS

Mechanic’s Lien Issues.

A landlord, in order to avoid having its underlying fee property title impacted by a mechanic’s lien asserted by an unpaid contractor working on a tenant improvement, must take a number of proactive steps: First, it must ensure that the tenant complies with Nevada law and secures alternatives to the lien rights for the contractors (a bond or moneys on deposit in a collection control account), and then, it must itself record a Notice of Non-Responsibility (which is however only effective if the Landlord has first ensured that its Tenant is in compliance).

MECHANIC’S LIEN PROTECTION CLAUSE EXAMPLE

Protection Against Mechanic’s Liens.

Part I. Tenant’s Duty to Keep Property Free From Liens. Tenant will not initiate its Tenant Improvements work until it has first obtained and provided to Landlord a copy of an UNCONDITIONAL WAIVER AND RELEASE UPON PROGRESS PAYMENT in the form required by NRS 108.2457(5)(b) executed by any party who has performed any off-site work for the Tenant Improvements including any architectural or design work, indicating that said party has been paid in full through the date thereof for the services or materials provided, which release shall be dated no later than one day prior to the date on which Tenant Improvements shall commence on site. Tenant will not permit any mechanics’ or materialmens’ liens to be attached to Landlord’s property, including the Building, the surrounding property set forth on Exhibit G, or Landlord’s underlying fee interest in the Building and the Demised Premises, for any labor or materials furnished to Tenant in connection with work performed at the Demised Premises, including all of the Initial Tenant Improvements as described herein, or for any other repairs or alterations made at any time during this Lease to the Demised Premises. If any mechanics and/or materialmens’ lien or similar lien of any contractor, subcontractor, supplier, design professional, or any other party providing work in conjunction with the Tenant Improvements shall be filed against any part of Landlord’s property due to Tenant’s actions or by any party working to improve the Demised Premises or benefit the Tenant, then Tenant shall, within thirty (30) days after being notified in writing of the filing of such a lien, cause the lien to be discharged of record either by paying the same, or by procuring the discharge thereof pursuant to the provisions of NRS 108.2413 through 108.2425, inclusive, by posting a bond in the amount of one and one-half (1 1⁄2) times the amount of the lien, and obtaining an Order of a Court of competent jurisdiction removing the lien. If Tenant shall fail to cause such lien to be discharged within said thirty (30) day period, Tenant shall be in default under this Agreement, and in addition to any other remedy at law or in equity, Tenant may, but shall not be obligated to, discharge the lien by either paying the amount claimed to be due or by procuring the discharge of the lien by following the aforesaid statutory procedures found in NRS 108.2413 through 108.2425, inclusive. Thereafter, Tenant shall be entitled, if Tenant so elects, to then pay the amount of any judgment on the lien (or any judgment against any bond posted to remove the lien) in favor of lienor, with interest, costs and allowances. Any amounts so paid by Lessor and all related costs and expenses incurred by Lessor, together with interest at the rate of 10% per annum shall be paid by Lessee to Lessor upon demand.

Part 2. Tenant’s Duty to Enable an Effective Notice of Non-Responsibility. In addition to the foregoing, prior to commencing any work with respect to Tenant Improvements or alterations or repairs within the Demised Premises (including without limitation, any prior architectural or design work or other offsite work for which an Unconditional Waiver and Release Upon Progress Payment has not already been received, as aforesaid), the Tenant shall be required to comply with all of the obligations set forth in NRS 108.2403 through 108.2407 so as to allow Landlord to maintain the status of a disinterested owner who can record a notice of nonresponsibility under NRS 108.234. This means that Tenant is required to take the following steps, in addition to any other steps which may be required by the version of the statute then in effect at the time of the commencement of any construction or alteration or repair of any work at the Premises:

Before commencement of work or delivery of any materials for the tenant improvements, whichever shall first occur, Tenant must inform Landlord of the anticipated date of commencement of construction and record a Notice of Posted Security with the Clark County Recorder’s Office and either (i) establish a Construction Disbursement Account as described in (a) below, or (ii) record a surety bond for the Prime Contract as described in (b) below.

(i) If Tenant elects to establish a Construction Disbursement Account, Tenant must (i) fund the Construction Disbursement Account in an amount equal to the total cost of the work of improvement, which such amount cannot be less than the total amount of the general contract (hereinafter the “Prime Contract”) which Tenant enters into with his general contractor (hereinafter the “Prime Contractor”); and (ii) obtain the services of a Construction Control to administer the Construction Disbursement Account and (iii) notify each person who gives Tenant a notice of right to lien of the establishment of the Construction Disbursement Account by either of the two methods provided in paragraph (c) below. Upon the disbursement of any funds from the Construction Disbursement Account for a given pay period, Tenant shall deposit into the Construction Disbursement Account any additional funds as may be necessary to pay for the completion of the work of improvement, including, without limitation, the cost attributable to additional or changed work, material or equipment. The Construction Control must certify in writing the amount necessary to pay for the completion of the work of improvement and, if there is a discrepancy, the Construction Control shall give written notice of the deficiency by certified mail, return receipt requested, to the Prime Contractor and each person who has given the Construction Control a notice of right to lien.

(ii) If Tenant elects to record a surety bond for the Prime Contract, Tenant must record a surety bond that meets all the requirements of NRS 108.2415(2) and notify each person who gives Tenant a notice of right to lien of the recording of the surety bond by either of the two methods provided in paragraph (c) below.

(iii) Tenant must serve a copy of the Notice of Posted Security upon each person who gives a notice of right to lien within ten (10) days after receipt of such notice of right to lien, in one of the following ways: (i) by personally delivering a copy of the Notice of Posted Security to the person who has given a notice of right to lien at the address identified in such notice of right to lien; or (ii) by mailing a copy of the Notice of Posted Security by certified mail, return receipt requested, to the person who has given a notice of right to lien at the address identified in such notice of right to lien.

Part 3. Tenant’s Obligation To Record Notice Of Completion. After the completion of the work of improvement on the Tenant Improvements, or on any other alterations or repairs which Tenant may ever cause to be performed at the Demised Premises , Tenant must comply with NRS 108.228 concerning recordation of a verified notice of completion (“Verified Notice of Completion”) and in addition to, and not in lieu of the requirements of this statute, Tenant must:

(a) Record a Verified Notice of Completion in the Office of the Clark County Recorder setting forth:

(i)  The date of completion of the work of improvement on the Right of Way;

(ii)  Tenant’s name and address and the nature of the title, if any, of the person signing the notice;

(iii)  A description of the property sufficient for identification; and

(iv)  The name of the Prime Contractor with whom Tenant contracted for the work of improvement on the Right of Way.

(b) After recording of a Verified Notice of Completion , Tenant shall, within 10 days of the date of recordation, deliver a copy of the notice by certified mail, to:

(i) The Prime Contractor with whom Tenant contracted for the work of improvement on the Right of Way; and

(ii) Any potential lien claimant who, before a Verified Notice of Completion was recorded, either submitted a request to Tenant to receive the notice, or delivered a preliminary notice of right to lien pursuant to NRS 108.245 (2005).

Frequently Asked Questions
What are the dangers of lien claims to a Landlord’s rights? Discuss

E. Delays and Termination

TENANT DELAY CLAUSE EXAMPLE

(a) Commencement Date. The Term of the Lease will commence on the date (the “Commencement Date”) which is the earlier of: (i) the date Tenant or any subtenant of Tenant moves into the Premises to commence operation of its business in all or any portion of the Premises; or (ii) the date the Building Shell and the Tenant Improvements have been “substantially completed” (as defined below); provided, however, that if substantial completion of the Building Shell or the Tenant Improvements is delayed as a result of any Tenant Delays described in Paragraph 9 below, then the Commencement Date as would otherwise have been established pursuant to this Subparagraph 8(a)(ii) will be accelerated by the number of days of such Tenant Delays. Notwithstanding the foregoing, the Rent Commencement Date shall be determined in accordance with Paragraph ___ of the Lease. For purposes of this Work Letter Agreement, “Tenant Delays” means any delay in the completion of the Building Shell or the Tenant Improvements resulting from any or all of the following: (a) Tenant’s failure to timely perform any of its obligations pursuant to this Work Letter Agreement, including any failure to complete, on or before the due date therefor, any action item which is Tenant’s responsibility pursuant to the Work Schedule delivered by Landlord to Tenant pursuant to this Work Letter Agreement; (b) Tenant’s changes to Space Plans or Tenant’s Final Plans after Landlord’s approval thereof; (c) changes to the Building Plans resulting from changes to the Tenant’s Final Plans after Landlord’s approval thereof; (d) Tenant’s request for materials, finishes, or installations which are not readily available or which are incompatible with Landlord’s standard specifications for tenant improvements for the Development; (e) any delay of Tenant in making payment to Landlord for Tenant’s share of the Work Cost; or (f) any other act or failure to act by Tenant, Tenant’s employees, agents, architects, independent contractors, consultants and/or any other person performing or required to perform services on behalf of Tenant.

Frequently Asked Questions.

What are the key provisions to carefully negotiate?

– A “tenant delay” should be clearly defined, and exclude events outside the control of the tenant or its agents.

– Notice of delay and cure periods, should be agreed upon and explicitly set forth;

– Whether to include additional tenant delay “free or cushion” days into the total time period of the build out should be negotiated ahead of time, either in calculating the total time to build, or by expressly setting forth a certain number of such “extra” days in the agreement.

– The penalties for delay should be clearly set forth: are they monetary penalties, or can the delay create a termination? If the latter, the impacted party should negotiate provisions to avoid forfeiture of costs expended.

– Items that will require a long lead time to complete or materials that will take a long lead time to receive should be discussed prior to agreeing on deadlines.

-Provisions for mandatory meetings between the tenant and the landlord to resolve issues as they arrive (either regular meetings every set number of days; or mandatory meetings before certain notices can be sent) should be built into the agreement to allow accommodations and workouts that avoid breaches or breach claims and resultant disputes.

About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah. Our firm’s practice includes a strong emphasis on personal injury accidents. Call us at 702-384-7111.

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