In the course of negotiating a retail lease, landlords are often requested to payfor a portion of the tenant’s cost of construction of the premises. The manner in which the landlord would make such a payment is commonly done by way of a “construction allowance” whereby a portion of the tenant’s construction cost is defrayed by a payment made by the landlord, which payment may or may not be incorporated into the rental structure that will then be owed by the tenant during the term of the lease. Several issues arise when contemplating the payment of a construction allowance to the tenant. In particular, issues such as the manner and timing for payment of the construction allowance, documentation required for the payment of the construction allowance, and repayment of the construction allowance in the event of a default by the tenant, should all be considered when addressing the issue of the construction allowance in the lease. This article will serve to address the foregoing issues and attempt to address various manners in which these issues could be addressed in the lease.

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  1. Manner and Timing of Payment[break][break] Typically, a tenant will request a construction allowance be made over time, by way of progress payments, as the tenant performs its construction of the premises. In contrast, the landlord would like to retain the construction allowance as long as possible, so as to assure that the premises is properly constructed, with all “punch-list” items completed, that the tenant has opened for business, and that all required documentation has been provided to the landlord. Often, a compromise is struck, so that a portion, sometimes as much as one-half (½) of the construction allowance, is paid to the tenant during the course of the tenant’s performance of its construction obligations (provided that the required documentation has been furnished to the landlord), with the remaining portion of the construction allowance being paid once the construction is completed, tenant has opened for business in the premises and all documentation has been furnished to the landlord. [See model provision at inset]. The Landlord should be certain that a substantial portion of the construction allowance not be paid to the tenant up front, so that landlord can insure the premises is property constructed and has sufficient funds remaining, in the even of any work that remains unperformed by the tenant. While the manner and timing for payment of the construction allowance will vary from deal to deal, generally no more that one-half (½) of the construction allowance should be paid to the tenant prior to the completion of all of the tenant’s construction work.[break][break]
  2. Documentation for Payment of the Construction Allowance[break][break] Regardless of the manner and timing of the payments of the construction allowance, no payment should be made to the tenant for any portion of the construction allowance without the proper documentation being provided to the landlord. At a minimum, the landlord should receive from the tenant, a contractor’s statement which identifies the general contractor, all sub-contractors and all materialmen that furnished labor or supplies towards the performance of the tenant’s construction work. Further, concurrently with the submission by the tenant for the requested draw from the construction allowance, partial lien waivers at least equal to the amount of the draw request should be furnished to the landlord, which lien waivers should coincide with those amounts shown on the contractor’s statement. Also, there should be a statement issued by the architect which identifies the portion of the construction that has been completed by the tenant at the time of the draw request. Generally, the portion of the construction work that has been completed by the tenant should be in the same proportion has the draw request relates to the total construction allowance.[break][break]Once, all of the tenant’s construction work is completed, the tenant should then be permitted to make its final draw request for the balance of the construction allowance. However, final documentation needs to be furnished by the tenant, before the landlord should be obligated to make the final payment under the construction allowance. In particular, the tenant should be required to furnish the following documentation:[break][break]
    1. (i) a final contractor’s statement identifying the general contractor, all sub-contractors, and all materialmen involved in the performance of the tenant’s construction work;[break][break]
    2. (ii) final waivers of lien from the general contractor, all sub-contractors and the materialmen who have furnished labor or supplies in connection with the tenant’s work. Often there is a diminimous standard established between the landlord and the tenant, whereby contractors, sub-contractors and materialmen that furnish less than a minimal amount of work or supplies for the performance of tenant’s work (e.g., less than $2,000.00) do not need to provide lien waivers, but this diminimous standard will vary with the strength of the tenant and the amount of the construction allowance;[break][break]
    3. (iii) a warranty of issued by the general contractor in favor of the tenant and the landlord, which warranties all construction work against defect and labor or materials for a period of one (1) year from the completion of construction;[break][break]
    4. (iv) a set of final “as-built” plans, identifying all differences from the actual construction work performed by the tenant as compared to that construction work identified on the tenant’s plans and specifications; and[break][break]
    5. (v) an estoppel certificate identifying the material terms and provisions of the lease. This estoppel certificate is especially important if the construction allowance is being funded by a loan that is being provided by the landlord’s lender.[break][break]Once all documentation is being provided to the landlord in sufficient form, the balance of the construction allowance should be tendered to the tenant. As a precondition for funding the construction allowance, all of the tenant’s work, including all punch-list items, should be completed and the tenant should have opened for business in the premises.[break][break]
  3. Payback of the Construction Allowance in the Event of a Default by the Tenant[break][break] To the extent that the amount of the construction allowance has not been incorporated into the amount of rent being by the tenant, there should be a provision in the lease which provides that the tenant will be obligated to repay the unamortized portion of the construction allowance, in the event of a default by the tenant and the termination of the lease by the landlord. In the event that the construction allowance has been incorporated into the rent, then the default provisions of the lease typically will provide that all future rent (or at least the present value there of), will be payable by the tenant as a calculation of a portion of the landlord’s damages for the tenant’s default. As a result, it is not necessary to separately provide for such amount in the construction allowance provision, however, to the extent that the construction allowance has not be incorporated into the rent, in order to make the landlord whole for the tenant’s default, the construction allowance provision should provide for a repayment of the unamortized portion of the construction allowance. The amortization of the construction allowance should be done on a straight line basis over the term of the lease.[break][break]
  4. Conclusion[break][break] By carefully documenting the manner in which the construction allowance is to be paid, the documentation that is required and the means by which the construction allowance should be repaid in the event of a default by the tenant, the landlord can protect itself from making a payment to the tenant, without receiving the benefit of its bargain from the tenant, without risking mechanic liens or other duplicate of payments of the amounts that are to be covered by the construction allowance.

American Lawyer Media, Commercial Leasing Law & Strategy Volume 20, Number 10, March, 2008

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