Construction issues come up in a variety of ways in a lease. There are a lot of different lease provisions that are either directly or indirectly related to construction, including the work letter, signage, maintenance and repair obligations, co-tenancies, improvement allowances, alterations, operating expenses, opening dates and penalties, and many more. One of the most important construction issues to consider when negotiating a lease is defining the scope of work accurately and completely.
Most leases contain a work letter exhibit that covers, among other things, the scope of the work that the landlord intends to perform before delivering the premises to the tenant. Typically, one of the first steps in the process of selecting a location involves the parties performing a site inspection of the premises and determining what changes need to be made in order to make the space work for the tenant’s intended purpose. The parties then negotiate the scope of work and come up with a list of items that the landlord will be required to provide. That list is either contained within a letter of intent/business term sheet or attached as a separate schedule to the LOI (note, in some cases, there is no landlord scope of work and the parties simply agree that the tenant will take the space “as-is”). The more specific the description of the landlord work the better, as general descriptions can lead to false assumptions and other misunderstandings between the parties that can result in disputes that may substantially change the economics of the agreement, or worse, kill the deal altogether. Even when a landlord’s scope of work is drafted with sufficient details, problems may arise. It is not uncommon for a landlord to review the scope of work and timing issues more carefully when a lease is about to get signed and discover that some of the details that initially seemed doable will no longer work because some prior assumptions turned out to be false. Consequently, the details of the landlord’s work often change between the time the parties reach agreement during the LOI stage, and the time the parties are ready to sign the lease.
Other times, landlords revise the scope of work definition from the schedule on the LOI to more accurately describe the work. In many cases, these revisions are merely intended to be clarification changes rather than substantive changes. For example, the work letter included with the LOI may have a vague statement regarding landlord’s construction of a demising wall, but during the lease negotiations, more description might be added regarding the construction of the wall (e.g., the types of materials used) and/or its location. But tenants should carefully review these revisions because in many cases, these revisions end up being at least partly substantive.
When mistakes in the scope of work are discovered after a lease is signed, many undesirable outcomes may follow. The most obvious concern is increases in costs of construction, but there are many other indirect problems that can result in serious consequences. F
or instance, delays in construction could lead to a landlord being subject to late delivery penalties, or worse a tenant termination right. Delays will result in lost rent. Delays can also have a domino effect of causing the landlord to violate co-tenancy obligations. From the tenant’s perspective, delays can lead to lost sales, loss of seasonal products, potential holdover rent from another location to be closed in anticipation of the new space, employee hiring delays and many more.
To avoid these costly risks, landlords and tenants should carefully review the scope of work throughout the lease negotiation process and ensure that what is included in the lease is complete and accurate.