Facing the “Big Unknown”

April 2014

New Building Issues

Negotiating offers and leases for new space in an existing building requires careful consideration of a number of issues such as landlord’s work, possession date(s), fixturing period(s), improvement allowances and remedies (if any) in the event of delay, along with all the other lease issues dealt with by landlords, tenants and those that represent them in commercial lease transactions.  The big unknown factor is the possession date.  In most cases, the experience and expertise of those involved can reduce the unknown element to an acceptable range that gives both parties sufficient flexibility without inflicting financial hardship on either.

The big unknown, however, gets even bigger if the building has not been built and the only thing to look at is a handful of concept plans and specifications.  Three to four years is the average time it takes for a downtown high rise office building to be constructed in major urban centers.  Delays of all kinds, both before and during construction, are a very real possibility.  The “what happens if” question is frequently asked in the context of negotiations and, in the process, the various risks associated with delays have to be identified and allocated between landlord and tenant.  This must be done in the context of all the other issues and concerns that need to be addressed in the course of a lease negotiation.  This article highlights some of the major issues that should be addressed in a new building situation.

Plans and Specifications
The more detailed and concise the plans and specifications are, the less likelihood there will be of unwanted and unintended results.  These should be reviewed by architects, designers and other expert consultants to ensure that all the requirements, as far as they can be determined in advance, are included.

Milestone Dates
It is critical to have a schedule setting out at least the important dates of various phases of construction, such as demolition, completion to ground level, concrete top off, curtain wall completion and so on.  Providing for such milestone dates is one thing but negotiating what remedies are available in the event milestones are not achieved is quite another.  From a landlord’s perspective, its ability to obtain financing may be compromised if tenants have a right to terminate in the event milestone dates are not achieved.  Tenants, on the other hand, need to look out for themselves to ensure that they are not forced out of their existing premises before their new premises are completed.

Outside Dates
In addition to milestone dates, there should be at least two outside dates.  The first outside date would be a date by which construction must begin and the other outside date would be a “drop dead” date by which the new building must be completed.  The failure to meet an outside date would give rise to the tenant’s right to terminate, usually within a specified period of time.

Inspection Rights
The tenant should have the right to enter the construction site at reasonable times, at its sole risk, to view the progress of the development and to fine tune its specific plans and specifications for its premises.

Change Orders
There should be a mechanism in place whereby a tenant can request a change to certain parts of the landlord’s work that directly affect the tenant’s premises.  This should include a method to determine the cost and a process to address any delays resulting from the change order.

Expansion/Contraction Rights
In view of the fact that a tenant’s needs may vary over the course of construction (3 to 4 years on average), it is not unusual for a tenant to negotiate the right to acquire additional space or reduce its space requirements by a certain percentage.  This flexibility obviously benefits the tenant but, from the landlord’s perspective, it limits its ability to market the remaining space in the new building.

Possession Date(s)
As indicated at the outset, this is the big unknown.  This should not, however, detract from setting a target or estimated date as well as an acceptable delay period for both parties.  For larger tenancies, it is quite common to have staggered possession dates so that a tenant would take possession of its premises in two or more tranches.  If that is the case, the corresponding fixturing periods would start and end at different times.  In order to avoid confusion and overlap, there should be a sufficient notice period of any anticipated possession date, pre-possession date inspections and pre-possession date remedial work (if any).

Deliverable Condition
In a perfect world, the landlord’s work would be fully (or at least substantially) completed, there would be no deficiencies, there would be no landlord’s materials or workers in the premises, all building systems would be fully functional, including the elevators and so on.  In reality, however, that is seldom the case.  The concept of “substantial completion” can be modified to a less onerous requirement of “deliverable condition,” which is a term that the landlord and tenant can define in a manner acceptable to both of them.  For a tenant to be able to do any work, it needs, at a minimum, the building to be fully enclosed (with the possible exception of an opening or “zipper” to accommodate construction elevator service), heat (especially in case the building was under construction in Canada in the winter of 2013-2014!), utility services and other basics to enable the tenant to carry out its work.

Deficiencies
There should be an efficient method of dealing with deficiencies.  During a pre-possession date inspection, the deficiencies should be listed and reviewed with the landlord.  They may be serious enough to delay the possession date.  Alternatively, the tenant should have the right to take possession even though the deficiencies have not been remedied, so long as this does not affect the landlord’s obligation to remedy.  Once the tenant has taken possession, there should be a time limit within which the tenant can require the landlord to remedy deficiencies (subject to any warranties that may have been negotiated).

Dispute Resolution
While most leases include arbitration and mediation provisions, these do not readily lend themselves to resolving disputes arising during the course of construction.  Consider naming a qualified expert (and one or more additional experts as back-up) to call on for a quick final and binding decision in the event of any dispute arising.  The main point is that the resolution should be done quickly so as not to compound the problem further with delays.

Delay Liability
The normal argument is that the landlord (who is in charge and control of construction) should be responsible for delays, unless caused by force majeure or by the tenant.  That said, the outside dates referred to earlier should not be subject to force majeure.  The definition of force majeure should also be closely considered so that lack of funds, reasonably foreseeable shortages of materials or other events are not included.

Delay Remedies
The right to terminate may be appropriate in certain circumstances, such as failure to meet an outside date.  In many situations, however, termination rights provide relatively little, if any, comfort to a tenant who needs new premises.  The more effective remedy would be damages.  There could be one or two days free rent for every day of delay, for example.  This provides the landlord with a powerful incentive to complete its work.  Just as important is the tenant’s continued ability to carry on its business.  If the only means by which this can be accomplished is to extend the term of the tenant’s existing lease, then this remedy should be available and any difference in the rent should be paid by the landlord.  In these circumstances, the landlord will want to ensure that it controls the negotiations regarding the extension of any existing lease.  In addition, it may be necessary for the tenant to relocate to different premises or to swing space and these added costs need to be considered.  On the one hand, the tenant wants comparable premises with comparable improvements and other amenities.  On the other hand, the landlord does not want these additional costs to get out of hand or be unreasonable.

Lease negotiation in a new building situation raises many issues.  How these issues are resolved and how the risks are allocated depends, in large measure, on the bargaining strength of the parties.  Awareness and a full appreciation of the risks are the first steps in planning for contingencies and reducing the big unknown factors as much as possible.

Miller Thomson is proud to be part of the team that won the Office Lease of the Year Award at the 13th Annual REX Awards on April 9, 2014.  The winning team included Ernst & Young LLP, Cushman & Wakefield Ltd and Oxford Properties Group. Click Here to view the other award categories and their finalists.

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