Control Your Share of Lease-End Capital Improvement Costs

Most tenants don't want to do and pay for lease-end capital repair, improvement, or replacement work if the useful life of the repair, improvement, or replacement will extend beyond the lease term. A popular compromise in this case is to hold the tenant responsible only for the amortized cost—rather than the full cost—of the work, based on the number of months left in the lease term. Under this compromise, you would reimburse the tenant for the unamortized cost of the work—that is, the portion falling outside the lease term.

But many leases that use this compromise have this potentially damaging loophole: The lease doesn't give you the right to control the tenant's lease-end capital repair, improvement, or replacement work to prevent the cost from getting out of hand. Without any control, you could be forced to pay most of the cost of unnecessarily expensive work.

Put Three Controls in Lease to Plug Loophole

One way to help you keep lease-end capital repair, improvement, and replacement work from being unnecessarily expensive is to include the following three controls in your lease, suggests Los Angeles attorney Pamela Lynne Westhoff. You're most likely to use an approach like this when the tenant is leasing all or most of your building:

Get notice before big expenditures. If the tenant's required capital repair, improvement, or replacement work will affect the building systems or structure in any way or cost more than a set amount—say, $50,000—require the tenant to notify you in writing before it performs that work, suggests Westhoff. The tenant's notice must say exactly what work needs to be done and how much it will cost, she says. You need this information so you can decide whether you want to put the brakes on any repair, improvement, or replacement work that could end up costing too much.

Choose who performs work. Get the right to choose whether you or the tenant will perform the required repair, improvement, or replacement work, says Westhoff. You may not want the tenant to do it if, for example, you think you can do a better job for less money, she points out. If you choose to perform the work, make sure that the tenant is responsible for paying its share of the cost as part of CAM costs or operating expenses, she adds.

Require compliance with alterations clause. To avoid any dispute with the tenant over whether its work involves an “alteration,” get the tenant to agree that if you choose to let it perform the required repair, improvement, or replacement work, it will meet the requirements and conditions set out in the lease's alterations clause, says Westhoff.

The alterations clause should: 1) require the tenant to give you detailed plans and a budget for the proposed work; 2) let you approve the tenant's contractor; and 3) require the tenant to give you special security—such as a completion bond—to guarantee that the work will get done properly, advises Westhoff. These alterations clause requirements and conditions should enable you to monitor and control the cost of the tenant's work.

Practical Pointer: Make it clear that, even though you want notice and control over the expenditures, you aren't modifying in any way the tenant's obligation to perform or pay the cost of the capital repairs, improvements, or replacements, says Westhoff.

Add Lease Language

To get those three controls, add the following language to your lease where it discusses reimbursing the unamortized portion of the cost of the capital repair, improvement, or replacement, advises Westhoff: CLLI0092

Model Lease Language

a. Notwithstanding the foregoing or anything to the contrary herein, if any capital repair, improvement, or replacement required during the last [insert #, e.g., 2] years of the Lease will:

(i) Affect building systems or structure, or

(ii) Cost in excess of $[insert amount, e.g., $50,000],

then Tenant shall, prior to commencing such work, notify Landlord, in writing, of the work required to be performed and the projected cost thereof.

b. Within [insert #, e.g., 10] days following receipt of Tenant's written notice, Landlord shall notify Tenant, in writing, that Landlord either elects to perform the required work or authorizes Tenant to perform the required work.

c. If Landlord elects to perform the required work, Tenant shall reimburse Landlord for its pro rata share of the cost of such work as part of [CAM Costs/Operating Expenses] under this Lease.

d. If Landlord authorizes Tenant to perform the required work, then Tenant's performance shall meet the requirements of Clause [insert # of alterations clause] hereof.

e. The foregoing requirements shall not be deemed to modify any of Tenant's obligations to perform and/or pay the cost of capital repairs, improvements, or replacements as set forth in this Lease.

CLLI Source

Pamela Lynne Westhoff, Esq.: Partner, DLA Piper Rudnick Gray Cary US LLP, 550 South Hope St., Ste. 2300, Los Angeles, CA 90071; (213) 330-7747; Pam.Westhoff@dlapiper.com.