Drop-Dead Delivery Date: Is It Worth the Risk?

by Jonathan Newman, Esq.

One thing you do not like to hear when negotiating a commercial lease agreement is that the tenant must have possession of the space by some important date, known as the “drop-dead date.” Why? Because the tenant usually wants the landlord to suffer a variety of draconian consequences if the drop-dead date isn’t met. Examples include free rent, significant monetary penalties, and sometimes, the ability for the tenant to terminate the lease agreement.

Weigh Pros and Cons of Granting Tenant’s Request

If a typical commercial lease transaction involved the re-letting of “as-is” space, this topic would not be as critical to landlords. However, at least in Class “A” office buildings, commercial landlords are spending significant monies upfront improving and customizing the office space for each new tenant. When an existing tenant vacates, more often than not, the entire suite is demolished and rebuilt for a prospective new tenant based upon a customized space plan, often at great expense.

Landlords are investors, and with each potential lease deal landlords expect to make a return on their investment. When the tenant proposes a drop-dead date, it puts the landlord’s investment return at risk. And with respect to a right to terminate, it opens up the possibility that the landlord will never obtain a return on the investment dollars expended. As a result, it is quite reasonable to ask if providing the tenant with a drop-dead date is worth the risk. The answer, as usual, is it depends. And initially, it boils down to a business decision, not a legal one.

Reasons a Tenant Might Have a Deadline

There are an infinite number of reasons a tenant might request a drop-dead date. And it’s prudent to inquire why the tenant’s particular drop-dead date is critical. Maybe the expiration date for the tenant’s existing lease is fast approaching and the tenant will incur stiff “holdover” penalties if it has not vacated by the drop-dead date. Maybe the tenant has a seasonal business model (think tax preparation or Christmas for retailers) and the tenant would incur unthinkable business losses if it is not operational by the drop-dead date. Maybe the tenant simply wants to be able to plan its move with certainty and make sure the landlord can perform the promised improvement work in a timely manner.

Don’t Confuse Someone Else’s Time Frame for Your Own

Let’s take an extreme example and say the reason why the drop-dead date is critical is that the tenant’s existing lease is expiring in 14 days and the tenant does not want to pay the 200 percent holdover penalty. At a minimum, the lease still needs to be negotiated. Possibly improvements need to be contracted for and then performed. Permits may need to be pulled.

Think about it: This is not the landlord’s fault. The landlord did not cause that crisis, and the landlord should not be penalized as a result. Most likely, the tenant itself did not leave sufficient time to search for new space, negotiate a new lease document, and allow for potential construction time. It’s very important not to confuse the tenant’s time frame for your own. In this type of situation, the tenant created its own chaos and it is clear the landlord should not accept any risk if the tenant’s move is not accomplished in 14 days.

Is the Tenant’s Proposed Time Frame Realistic?

Putting aside fault, the most critical question to consider is if the time frame proposed by the tenant is realistic. Is there sufficient time for the landlord to complete its responsibilities before penalties come into play? Defining the landlord’s responsibilities is more complicated than it seems.

Let’s say a new 5,000-square-foot prospective tenant proposes a 150-day deadline for its possession. Assume no lease has been negotiated or signed and no construction documents have been drafted. However, the parties have already agreed to a letter of intent and a space plan, and have received a soft construction estimate of 60 days for construction, including permits. Can it be done in 150 days? To answer that question we need, among other things, a solid timeline and we need to know: (1) exactly what must be done (and by whom); (2) if there is adequate time to accomplish all requirements; and (3) whether or not completion of the same is within the landlord’s reasonable control.

The scope of this article cannot provide the detail required to answer the above questions, but we can confidently propose that there are a large number of moving parts. There are typically numerous parties involved in the process (the landlord, tenant, space planner, architect, general contractor, and government inspectors)–and countless opportunities for delay. The lease itself could get bogged down in negotiation. The space plan/construction document could end up going through many, many revisions and changes. The government inspectors/permit process could be backlogged. The drawings might get caught up in the system or be denied outright.

With so many moving parts and so many particulars that are outside of the landlord’s reasonable control, it might seem that landlords should never accept liability regarding a drop-dead date. But, in the world of business in general and commercial leasing in particular, taking the ultra-safe route is not realistic either. In business you have to balance risk and reward. If the potential tenant is creditworthy and the proposed business terms are attractive, some risk may be worth taking. At that point, if you decide to accept some risk, your success boils down to acting prudently and mitigating the risks you agree to take. A carefully drafted lease clause, like our Model Clause: Limit Tenant’s Free Rent for Delayed Possession, can help you do just that.

Consider Restrictions When Agreeing to Accept Liability for Delayed Possession

Below are six key issues to consider before agreeing to accept liability for delayed possession:

Issue #1: What is the penalty? A key issue for the landlord and tenant to agree upon is the penalty if the tenant’s drop-dead date is not achieved. There are no standard rules, and creativity is often an advantage. Should the penalty be capped? Should the penalty increase or decrease over time? The possibilities are limited only by the parties’ imaginations. However, some typical penalties include:

> Holdover penalty. It is not uncommon for the parties to agree that the penalty will be the landlord’s reimbursement of the tenant for all holdover charges incurred (or some portion of those). In this situation it is prudent to obtain a copy of the tenant’s existing lease document to confirm the timing, amount, and other specifics related to the tenant’s holdover. Sophisticated landlords will often suggest a “cap” or maximum amount to be incurred by the landlord to further mitigate their liability.

> Free rent. Providing one day of free “base” rent for each day of delay beyond the drop-dead date is also a solution that is agreed to with some frequency by landlords and tenants [Clause, par. 1]. Some landlords prefer this avenue because it does not require any cash payment to the tenant. Once again, negotiating a “cap” or maximum amount of free rent is always worth pursuing.

> Liquidated damages. Sometimes, rather than abated (free) rent, the parties will agree to the landlord paying “x” dollars for each one day of delay beyond the drop-dead date. There are numerous variations on this theme. Maybe the daily amount starts small and increases over time (providing a smaller penalty if the delay is short-lived). Or, maybe the opposite approach is better, where the daily amount starts off with a large number (providing an incentive for the landlord to finish quickly). Once again, creativity in drafting solutions is unlimited and often advantageous. Furthermore, keep in mind that most of these “variations” can also be applied to the other penalty types. As always, incorporating a “cap” or maximum remains advantageous for the landlord.

> Termination of the lease. Providing an option for the tenant to terminate the lease should be avoided in most situations. After all, the drop-dead date is usually somewhat arbitrary. Imagine a situation where the landlord has spent significant capital ($100,000 or more is typical) customizing the premises to the tenant’s specifications, but misses the drop-dead date by just one day? Or one week? It seems fundamentally unfair to allow the tenant to simply walk away leaving the landlord basically holding the bag. Where termination options are given, it’s usually only after a very generous time frame has elapsed, including a substantial “cushion” of time to protect the landlord.

Issue #2: Adequate time frame and prerequisites. The only way to determine whether or not the landlord has an adequate window of time is to specifically identify all items that are: (1) the landlord’s sole responsibility; and (2) subject to the penalty if they are not completed by the drop-dead date [Clause, par. 1]. All other items should be defined as “Prerequisites” [Clause, par. 2]. Prerequisites represent the requirements that must be accomplished before the clock starts ticking on the landlord’s work. It’s often helpful to create a visual timeline similar to the following:

The timeline is very important. In the above timeline, we have identified and defined the prerequisites as: (1) the lease negotiation; (2) the space plan; (3) the construction drawings; and (4) the permits. In addition, the timeline shows that the landlord’s obligation to perform the construction starts after the prerequisites have been fully satisfied. Finally, the timeline gives the landlord 90 days (60 days for construction plus a 30-day cushion) to complete its obligation before a penalty is assessed. With this information, we now have enough information to fill in the appropriate “blanks” in the clause.

Issue #3: Right to possession. The lease clause should require only that the landlord provide the tenant with a right to possession as opposed to actual possession. The landlord cannot force the tenant to physically move in if the tenant chooses not to [Clause, par. 1].

Issue #4: Remedies. It is important to define the penalty (that is, free rent, holdover reimbursement, etc.) as the tenant’s “sole and exclusive” remedy if the drop-dead date is not met [Clause, par. 3].

Issue #5: Extensions to trigger date. It is equitable to allow the landlord an extension to the drop-dead date in certain circumstances [Clause, par. 4]. Those circumstances might include: (1) force majeure events; (2) reasons outside of the landlord’s control; and (3) tenant delays.

Issue #6: Exclusions. There are some circumstances when a landlord should not be responsible if the drop-dead date is not met. What if the tenant intentionally interferes with the landlord’s efforts or defaults on its lease obligations? It’s crucial to include these circumstances in the provisions [Clause, par. 5].

Jonathan Newman, Esq. is a real estate attorney with over 25 years of experience in commercial leasing, with an emphasis on landlord representation.