Determining Obligation to Pay for Capital Improvements

Q: There are several retail tenants in my building, which I plan to convert to a condominium building with both commercial and residential units. I sent notices to the tenants announcing the plan and letting them know that they’ll be expected to contribute their pro rata share of the cost of the conversion. One tenant has balked at covering part of the cost of the updates that will be made. It’s arguing that it’s not responsible for such “capital improvements.” Can I make the tenant pay?

A: As with many disputes between an owner and tenant, the lease is likely to control the outcome. Responsibility for paying a portion or the entire cost of a capital improvement is typically covered in the lease, so check yours with the tenant and consult your attorney before making any more demands. A recent New York case highlights the importance of paying attention to lease terms before assuming that a tenant can be charged for certain items.

Tenant Contests Façade Assessment

In that case, a building’s owner asked its ground-floor retail tenant to pay a pro rata share of an assessment that would fund the overhaul of the façade of the building, which was being converted to a condominium. The tenant asserted that it wasn’t obligated to pay the more than $300,000 in assessment fees that the owner demanded.

Ultimately, it moved out of the space part way through its lease term and sued the owner, asking a court to declare that it wasn’t obligated to pay any part of the façade restoration assessment. The owner filed a counterclaim, seeking a declaration that the lease and guaranty obligate the tenants to pay a proportionate share of the facade assessment, and seeking a money judgment for the tenant’s payment and breach of its lease.

Lease Controls Outcome

A New York court ruled in favor of the tenant. It noted that the owner mistakenly relied on the lease to support its assessment request. The court said that, rather, the terms of the lease make it clear that the tenant isn’t required to pay any portion of the facade restoration capital improvement assessment.

The language of the lease reflects that the tenant and owner contemplated the possibility of converting the retail building into a condominium from the outset. However, the “condominium conversion” provision of the lease provides that although the owner reserves the right, at any time during the term, to turn the building to a condominium form of ownership, it also acknowledges that the tenant’s monetary obligations “shall not increase as a result of such compliance.” This language was included to protect the tenant from additional costs and obligations that could arise in relation to a condominium conversion.

The lease obligates the tenant to pay common area charges, but specifically excludes “capital improvements” from the definition of those charges “to the extent that they are not in furtherance of reasonable or necessary maintenance of the building.”

The court decided that the owner couldn’t reasonably argue that the nearly $3 million facade project, which it officially referred to as the "Facade Restoration Capital Improvement" is not in fact a capital improvement, or that restoration of the original cast iron exterior facade of the building constitutes necessary maintenance. The court pointed out that the owner provided no evidence that any repairs were necessary, much less an entire cast iron restoration project [Rogan LLC and Arthur Ryanv. YHD Bowery Commercial Unit LLC, June 2014].