Can Breaching Tenant Deduct TIA from Damages Owed to Owner?

Q: I signed a lease with a tenant who backed out of the deal shortly before moving into the space. The lease provided for a substantial tenant improvement allowance (TIA) because the building is new and needs not just the tenant’s requested improvements to its particular space, but also common areas, restrooms, a lobby, and a courtyard to be built in order to complete the building to lease to other tenants.

I’m suing the tenant for breaching the lease, and asking a court for damages in the amount of the tenant’s rent for the entire four-year lease. The tenant is arguing that it’s entitled to a credit to offset these damages in the full amount of the TIA. Is a court likely to agree to that credit, not apply a credit at all, or apply some other amount to damages?

A: It depends on the terms of your lease, but a Utah district court recently determined in a case with similar facts that the tenant wasn’t entitled to a credit in the total amount of the TIA as an offset against the damages it owed to the owner for breaching the lease. And an appeals court agreed. The owner’s lease in that case didn’t give the tenant the right to apply any of the TIA amount to damages in the event of a lawsuit. But a district court determined that the tenant was allowed a credit, just in a lower amount than the full TIA amount. That was due only to the fact that, post-breach, the owner had agreed to give the tenant an amortized amount that was a fraction of the full TIA. So another factor in your case could be whether you promised your tenant any credit after it breached the lease.

TIA Credit Case on Point

In the Utah case, an office building tenant signed a three-year lease that provided a TIA of over $600,000. Before moving into the space, the tenant’s staff and distributors staged a “walkout,” effectively negating the tenant’s need for a space to operate in. The tenant notified the owner that it wouldn’t be able to use the space or pay rent. The owner sued the tenant for breach of lease, asking a district court to award it the amount of unpaid rent for the three-year term.

A district court ruled in favor of the owner, awarding it over $700,000 in damages (the amount of rent due from the date of the breach until the end of the lease minus the amount the owner received from renting the building to replacement tenants.) But the district court also noted that in an invoice to the tenant following the breach, the owner had provided it with a monthly credit of $4,690.39—an amortization of the TIA, for a total $168,854.04 credit over the life of the lease. The tenant appealed, but a Utah appeals court upheld the decision.

On appeal, the tenant argued that the district court was mistaken when it gave the tenant a credit against the unpaid rent for only the amortized amount of the tenant improvement allowance rather than the entire $600,000 originally allotted for the TIA in the lease. The tenant said that the district court should have deducted the full tenant improvement allowance from any damages the tenant owed to the owner.

The appeals court noted that “when one party breaches a contract, the injured party is entitled to recover damages as measured by: (1) the loss in the value to him of the other party’s performance caused by its failure; plus (2) any other loss, including incidental or consequential loss, caused by the breach; less (3) any cost or other loss that he has avoided by not having to perform.

The tenant contended that its breach saved the owner from having to expend the more than $600,000 that the lease had originally obligated the owner to provide in tenant improvements and therefore the full tenant improvement allowance should have been credited as an offset against the amount of rent owed. But the owner argued—and the appeals court agreed—that the contemplated improvements amounted to simply “capital expenditures” that would have provided the owner value far beyond the life of the three-year lease with this particular tenant.

The appeals court pointed out that the building itself was essentially a hollow shell with concrete floors; the $600,000 in tenant improvements contemplated by the lease were necessary to provide a useable space for any tenant to conduct its business there. In part because the tenant was to be the first occupant of the space, the owner agreed to provide a specified tenant improvement allowance for basic needs, including flooring, paint, and individual offices. These were expenses that the owner would have had to expend regardless of which tenant it had contracted with for construction of the building; and the improvements would be the owner’s property once the lease’s term ended, resulting in an improved building that could be offered to prospective future tenants. “The owner’s offer to cover the cost of these basic improvements appears to be essentially a guarantee that the owner would be providing the tenant leased space that contained the basic infrastructure needed to conduct business,” said the appeals court. “Thus, the owner did not ‘save’ these expenses as a result of the breach,” it noted.

Additionally, after the breach the owner was still left with the expense of improving the space in order to rent the building to replacement tenants. Therefore, it wasn’t appropriate to view the maximum amount of proposed tenant improvements as simply an expense that was saved by the owner upon the tenant’s breach and that should be used as a credit against the damages the tenant owed.

Post-Breach Deal Allows for Amortized Amount

The appeals court emphasized that, in fact, the tenant wasn’t entitled by the terms of the lease to offset the damages award by the amortized amount of $168,854.04 of tenant improvements either. The district court merely applied that credit in recognition of the fact that the owner had voluntarily provided the tenant with such an offset during post-breach negotiations. The district court seemed to treat this credit as a sort of concession on the part of the owner that the court itself was willing to put into effect in the judgment, rather than as an obligation that the court determined the owner was required to provide, the appeals court concluded.

• Tech Ctr. 2000, LLC v. Zrii, LLC, December 2015