Timing of Payment of TI Allowance to Tenant
When negotiating a tenant improvement allowance, tenants (and their attorneys) often overlook a critical issue: the timing of the landlord’s payment of the allowance. Following is an example of typical “landlord-friendly” language that appears in the landlord’s form lease:
Tenant shall bear all Costs of Construction (as defined below) of the Tenant Improvements in excess of _____________ Dollars ($__________) per square foot (the “Tenant Improvement Allowance”). Landlord shall disburse the Tenant Improvement Allowance in one lump sum payment within thirty (30) business days after Tenant gives notice to Landlord that Tenant has opened for business in the Premises, subject to (a) Landlord’s receipt of: (i) evidence of the insurance required by the terms of the Lease (ACORD Form 25 or other evidence reasonably acceptable to Landlord), (ii) lien waivers and releases from Tenant and all of its contractors, subcontractors and suppliers, (iii) a copy of the certificate of occupancy for the Premises issued by the City, (iv) copies of all applications for payment, preliminary twenty-day notices, records of payments, the contract with the general contractor, all change orders, and an approved schedule of values and unit costs, and (v) copies of all invoices paid by Tenant in connection with the Tenant Improvements, and (b) Landlord’s inspection of the work, which Landlord shall complete within such thirty (30) business day period, and Landlord’s approval of the work as being in accordance with the Tenant Improvement Plans, which approval Landlord shall not unreasonably withhold (provided that Landlord shall not be deemed thereby to have approved the work for any purpose other than disbursement of the Tenant Improvement Allowance, and that Landlord shall have no responsibility for defective, incomplete, or nonconforming work that Landlord discovers or fails to discover by any such inspection).
The importance of timing of payment is illustrated by the following sample facts: The tenant is a start-up company with little cash reserves. The cost of the tenant improvements is $25,000. When agreeing to the TI allowance, the tenant thinks that the landlord will be paying for the cost of construction up to the amount of the allowance. The tenant does not realize, however, that the tenant must pay for the construction and receive reimbursement 30 business days after all of the above conditions are met. Further, the conditions to payment require the tenant to obtain lien waivers and extensive records, along with an independent inspection of the work by the landlord. Realistically, the tenant will not be reimbursed until 2-3 months after the completion of construction. The tenant still will need to pay rent during this period.
Consider further the following facts: The landlord is having financial difficulty and there are rumors that the landlord has not paid other tenants their TI allowances. The tenant does not want to pay its rent if the landlord will not be able to pay the allowance. However, the tenant does not have any offset rights (i.e., the two payments are considered independent obligations under the lease).
Given the current state of the commercial leasing market, I have been advising my tenant clients to require that the landlord establish a construction escrow and make the payments directly to the tenant’s contractor. The tenant should negotiate with its contractor that the contractor must meet the landlord’s payment conditions in order to receive payment. This is the best option for the tenant, because the tenant does not have to float the cash.
The next best option for the tenant is to negotiate a reasonable timeframe and conditions to reimbursement. A reasonable timeframe for reimbursement is 14 calendar days following delivery of a certificate of occupancy, certificate of completion from tenant’s architect, and final unconditional lien waivers from all contractors, subcontractors and suppliers.
Finally, the tenant needs to negotiate a right of offset against rent in the event the landlord cannot meet its payment obligations. The right of offset has been a common theme in my blog posts. If the landlord has any payment obligations under the lease (TI allowance, brokerage commissions, repairs, refurbishment, etc.), the tenant should have the right to offset these amounts against rent owed in the event landlord fails to pay.
Prior to using any language or concepts from this blog entry, consult with an attorney.
Ryan Rosensteel is a real estate and construction attorney licensed in Arizona. You can contact him at firstname.lastname@example.org.