7Common Pitfalls in Negotiating
Work Letters and Commencement Dates
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Mark C. Phillips, Esq
Regional Counsel, Western Region
TrizecHahn Office Properties Inc.
and
Gregory Hurley, Esq.
Kutak Rock

1. Introduction
2. The Mis-Match Game - Tenant or Landlord Build?
3. Supervision Fee? What Supervision Fee?
4. Where's The Plan?
5. Let Me In! Let Me In!
6. It Is What It Is and That's All That It Is
7. The Turn(Key)Ing of The Screw
8. Responsibility for Disabled Access Improvements   (provided by Greg Hurley)

DISCLAIMER
Announcement

1. Introduction

2. The Mis-Match Game - Tenant or Landlord Build?

There are only two (2) construction scenarios - the tenant-build and the landlord-build, determined by which party contracts with the general contractor. Each scenario must be matched with the appropriate method of determining the commencement date.

· In the tenant-build scenario, the outside commencement date is a fixed date (whether that date is specified [e.g., "April 1, 2001"] or determined by reference to another event [e.g., "90 days after full execution and delivery of this Lease"]).

· In the landlord-build scenario, the outside commencement date is the substantial completion of the improvements by landlord.

In each case, the commencement date may be earlier, if tenant elects to occupy the premises for the conduct of business prior to the outside commencement. Also, each of these outside dates should be subject to adjustment for delay caused by the party that is not responsible for the contracting. In the tenant-build scenario, the outside date would be further subject to adjustment for force majeure delay. These are long-established industry standards for shifting the responsibility for the economic loss resulting from delay to the appropriate party.

The dead giveaways that an error has been made in the negotiation of these issues is either:

· The association of the "substantial completion" concept with a tenant-build, or

· The association of the "fixed date" concept with a landlord-build.

Although there are rare cases in which deviation may be appropriate, deviation from these industry standards should be generally be viewed with suspicion.

3. Supervision Fee? What Supervision Fee?

Supervision fees are essentially a discount from the allowance that the landlord purportedly uses to cover the costs of landlord's participation in a tenant-build scenario. The fees may be defined as a fixed amount or a percentage of something. That something may be the allowance, or all or certain categories of the costs of performing the improvements, and may include both costs paid by landlord or tenant. There is no right or wrong in the why or how of computing these fees, there is only at issue the amount of this discount.

As such, this is an economic/business issue that should not be left for a tenant to first discover in the standard form of the work letter or lease. Avoiding discussion of the fee and how it will be determined, or "leaving it to the attorneys" as if it is a legal issue can only breed distrust in the prospective tenant. Distrust leads to suspicion that the landlord is playing games or hiding the ball not only on this, but other issues.

One landlord-build scenario is the "turnkey" build-out. In this scenario, all of the economic terms of the lease are negotiated based upon a defined scope of work set forth in sufficiently detailed plans and/or specifications that become part of the lease at execution. If the approved plans that are part of the lease are changed by the tenant after execution resulting in an increase in costs, then the tenant is responsible for payment of the same.

Execution of the lease by landlord and tenant should reflect their knowledgeable consent to all of the economic terms, including the cost of the improvements. This can only happen if the sufficiently detailed plans and/or specifications are actually available to attach to the lease at execution.

Nevertheless, the planning process is often mistakenly ignored or delayed by the parties while the lease is being negotiated. In order for the process to move forward to complete a successful lease transaction, several things have to occur while the documentation is being addressed:

· The landlord and tenant have to agree prior to the execution of the lease as to how the cost of planning will be absorbed, whether the transaction is completed or abandoned.

· The tenant's active participation in the planning process must be monitored by the landlord to assure that the plans will be completed in the time that the landlord expects to achieve the economic value assumed in the transaction.

· The cost of the improvements reflected in the plan must be accurately estimated (and re-estimated) so that the economics of the transaction can be adjusted accordingly.

If the foregoing cannot reasonably be achieved, then it is likely that a "turnkey" scenario is inappropriate for the proposed transaction.

Contrary to the foregoing situation, in this pitfall the tenant's planning process and business needs are permitted to get ahead of the negotiation of the documentation. The tenant has a pressing business need to occupy the premises by a specific date and focuses entirely on the planning process to the detriment of the documentation. This may result from the tenant having inadequate resources to address both issues simultaneously, or a mistaken belief on the part of the tenant that attorney's fees will be wasted if the tenant is not first entirely satisfied that the space will work for the tenant.

In any event, the result is a demand by the tenant that it be allowed to access the premises and start construction prior to the full execution and delivery of the lease. A landlord's initial response to this request should be: "Not by the hair of my chinny, chin, chin!"

The landlord's invitation to start construction is an invitation to further procrastinate in addressing the lease documentation, raise an unreasonable quantity or type of comments, or both. If the landlord is inclined to accommodate such a request, then it should not be to the detriment of landlord in completing the negotiation of the lease. Appropriate considerations are:

· Limiting the extent of the construction activities to that which will not harm landlord if the transaction is abandoned (e.g., limiting the activity to demolition of improvements that landlord cannot reuse in any event).

· Indemnity and security for restoration if the transaction is abandoned.

· The ability to stop any early construction without cause or penalty (including claim of landlord delay).

· Conditioning any agreement for early access on the receipt of all initial comments to the standard lease form with the understanding and acknowledgement that there are no more, and the commitment to a strict schedule for completion of negotiations.

The phrase "as-is" to a landlord means that the landlord is not going to spend anything or assume any obligation in regard to the improvements or conditions described as "as-is" unless an obligation is specifically set forth in the lease. Unfortunately, this phrase is later read by tenants to be "as it should have been" once they discover that certain unbudgeted items must be addressed.

Again, there is no right or wrong as to the use of this language - the goal is simply to achieve a meeting of the minds by the time that the transaction must be completed, preserving the economic expectations of each party.

For this meeting of the minds, several things must occur:

· The lease must define in reasonable detail the components of the building that are intended by the landlord to be accepted by the tenant in its "as-is" condition. In an industrial lease scenario, it may be entirely appropriate for the structural portions of the building to be included, so long as that is accepted by the tenant.

· The tenant must accurately assess the condition of any improvement to be accepted "as-is" that the tenant plans to reuse, both for being in good working order and condition, and in compliance with law.

· If improvements are not in compliance with current laws, the tenant must consider whether these improvements will be required by building authorities to be upgraded or modified in connection with other intended improvements.

The failure to address these issues as early as possible in the negotiation process will inevitably lead to delay.

Obviously, it is preferable for a landlord not to have to undertake these investigations, as the result will inevitably be a demand for the landlord to make representations and warranties based upon the expert opinions it obtains. These representations and warranties effectively become exceptions to the "as-is" language that conditionally obligate the landlord to make certain improvements. If representations and warranties are required on behalf of the landlord , they should be carefully drafted to be limited to actual knowledge of particular individuals, defined improvements and laws then existing and applicable to these improvements (if compliance with laws is an issue). Reasonable wear and tear should be an exception to any representation as to the condition or working order of improvements already in place.

One of the goals of a landlord in proposing a "turnkey" build-out is to achieve savings in the cost of construction, and to capitalize as much as possible on existing improvements (assuming the lease is of second generation space). In order to maximize this possibility, the actual cost of construction should not be shared with the tenant, provided that the cost is within the economic parameters assumed by the landlord in the negotiation of the rent; and, the tenant should not have any incentive to require more than is necessary for the tenant to occupy the space for the conduct of its business.

Nevertheless, it is not unusual to see the following description of landlord's obligation in a letter of intent: "Landlord shall improve the premises in accordance with a mutually agreeable space plans, not to exceed $25.00 per rentable square foot." Does this language describe a "turnkey" build-out or a landlord-build with an allowance? It does neither, mixing the concepts to the detriment of the landlord.

The tenant with the knowledge that the landlord is willing to spend $25.00/RSF has no incentive to economize by maximizing the use of existing improvements or avoiding unnecessary extras if it all falls within the defined "allowance." That is when the tenant "turns the screw" to realize the savings achieved within the defined "allowance" by insisting it be applied against trade fixtures, furnishings, or excused rent.

The best way for the landlord to stay entirely within the parameters of a classic "turnkey" is to avoid any confusion of the "allowance" and "turnkey" scenarios by taking the following steps:

• Avoid disclosure of landlord's budget for improvements.
  
  
• Agree to pay for one round of preliminary planning to determine the extent of the tenant's requirements before quoting a rental rate commensurate with the extent of the improvements being requested. This is a small price to pay up front to avoid later giving away much more in cash savings.
  
  
• Insist on use of landlord's architect, who will be employed by landlord. This helps control the process in that the landlord may discuss the budget with the architect to assist them in limiting the planning to realistic parameters, without disclosure of specific costs to the tenant. An architect that always designs to the limit of the budget will not likely continue benefit from the volume of landlord's business.
  
  
• Only discuss payment of excess costs with the tenant, and assist in reworking the space to meet both the tenant's and landlord's budget.

Responsibility for disabled access improvements is becoming a sticking point in many lease negotiations. In California and several other jurisdictions a tenant's improvement can trigger a landlord's obligation to bring the "path of travel" to the improved area (often from the curb or public access) into strict compliance with new access requirements. For example a TI that involves structural alterations, even if minor, could require a landlord to construct new accessible parking, new common areas, new restrooms, etc.

The cost of the improved access the landlord must provide could be several times the cost of the TI. While many building departments will recognize "hardship exceptions" for landlords, the real threat here is often delay. Often the building officials will not approve plans or issue a C of O for a TI until these path of travel issues are addressed.

* MCLE * MCLE * MCLE *