Draft Favorable Work Letter Terms Before Construction Begins

Many tenants need to customize the space they lease, whether it’s in an office building or shopping center. But altering space—even for simple improvements—can be complicated. So when signing leases, you’ll want to have a work letter agreement—a contract that establishes the terms and conditions of structural changes that will be made to the tenant’s space prior to moving in. A typical work letter agreement describes the arrangement between the owner and tenant—that is, the dollar amount of improvements the owner is willing to pay and the tenant’s promise to pay for the cost of improvements that exceed this amount.

But if the terms in your work letter agreement are not as specific as possible, you could end up fighting with your tenant about critical issues, such as the extent of construction the tenant has the right to do, its payment dates, and its responsibilities for contractors. To avoid potentially costly disputes later, follow these guidelines for drafting a clear-cut work letter agreement.

Don’t Wait Until Construction

If you’re in a rush to close the deal with a prospective tenant, don’t fall into the trap of entering into a work letter agreement that doesn’t obligate you and the tenant to do anything more than just “agree to agree.” At the very least, you must set a cost cap on either what you’re willing to reimburse the tenant for, or how much work you’re willing to do, in terms of dollar amounts. If it’s possible, draft a work letter agreement that’s even more specific. It should establish exactly what changes the space will undergo.

Specifying the scope of work that will be performed is important because the tenant might be planning construction that you’re not willing to have done to your building. You should determine what you’ll allow the tenant to do and then figure out the overall cost for everything.

But it’s not practical or necessary to enumerate or anticipate the exact materials, labor, or equipment the improvements will require. Instead of estimating the cost of each individual item, figure out generally how much everything will cost and then set the cost cap at that amount.

Make Definitions Unambiguous

Your work letter agreement won’t go into painstaking detail for every aspect of the tenant’s renovations. However, you must make sure that it includes definitions of key terms and assigns categories of responsibility to you and the tenant. For example, it’s important to clearly define what qualifies as a “base building improvement” or a “base, shell, and core.” For a definition that you can adapt, see our Model Lease Clause: Spell Out Work Letter Terms for Renovation. Defining these terms is crucial because work letter agreements almost always provide that such improvements will come out of the tenant’s—not your—pocket.

You should also clarify what the tenant may purchase with its tenant improvement allowance (TIA) if the work letter agreement says that you will pay for a specific dollar amount worth of tenant improvements. It can help you avoid the risk that the TIA will be used for equipment, personal property, furniture, or other items that will not become your property at the end of the lease term. Also, you probably aren’t willing to pay for items that won’t be of value to future tenants.

Address Contractor Issues

In addition to apportioning the costs of materials, equipment, and labor, your work letter agreement should address your liability and responsibilities for renovation contractors. If the tenant is constructing its own improvements, include a provision specifying the insurance the contractor and the subcontractors are required to carry. The work letter agreement also should specify that the contractors’ and the subcontractors’ commercial general liability policies must cover you as an additional insured. Include terms establishing that the tenant’s contractor and subcontractors will provide lien releases to you.

Remember that whoever hires the contractor should require it to guarantee that the work will be free of defects in materials and workmanship for at least one year. Make the warranty freely assignable. That way, if your contractor constructs the tenant improvements, you’ll be released from any liability for defects when you assign the contractor’s warranties to the tenant.

Remember that the tenant should always be responsible for hiring the architect or the space planner who prepares the plans—even if you’re paying those service providers’ fees. The agreement should also make it clear that the tenant will provide the architect or space planner with its program requirements and other space needs on a timely basis. This can insulate you from liability related to your potential failure to make sure all of the tenant’s wishes were included in the plans and specifications.

Set Payment Due Dates

If your work letter agreement provides that the tenant must pay a portion of the cost of the improvements, you need to set a due date for its contributions. Typically, tenants pay either 100 percent of their contributions up front or 50 percent in advance and 50 percent upon completion of the improvements, with the amount usually based on the contractor’s guaranteed maximum price or stipulated sum bid. However, some owners allow tenants to pay their share monthly, as the contractor’s monthly payment applications are submitted.

You also need to set a due date for the tenant’s first rent payment—the “commencement date”—which is usually triggered by substantial completion of the tenant improvements. Clarify what must occur before the tenant improvements are deemed substantially completed. (Many owners use the date on which the certificate of occupancy is issued or the date on which the building permit is signed as the commencement date.) Furthermore, if the tenant is doing the construction, make sure the work letter agreement establishes a right to terminate if the improvements are not completed by a certain date.

If you’re worried that you won’t be able to cover all the bases when authorizing tenant improvements in your space, designate a decision maker and include his or her contact information in the work letter agreement. If there’s an unanticipated question, you’ll need one—and there will always be questions.