Ensure Reimbursement for Pre-Lease Plans When Deal Falls Through

Many office building and shopping center owners focus on the terms of the lease itself, forgetting that pre-lease agreements leading up to the start of the tenant’s term can make or break the deal from the start. But what about a scenario where the lease term never actually starts? If a lease deal doesn’t come to fruition, you may be left on the hook for costs of items that were necessary to push the deal forward. And that could be very, very high. The expenses to hire experts, such as architects, to draw up plans for the space could be in the thousands. If the plans are specific to that particular tenant’s operation in the space, they’ll be useless for the next tenant; you’ll have to start the process—and pay the costs—all over again.

You can, however, get reimbursed for the cost of architectural plans if your lease deal with a tenant you were counting on falls through. Requiring the tenant to indemnify you for architectural and similar types of pre-lease plans, like engineering plans, protects you from paying for plans you can’t use later. 

Are You at Risk for Getting Burned?

Not all prospective tenants need architectural plans right away. But sometimes a prospective tenant needs to occupy new space so quickly that it wants you to start the buildout process before it signs your lease. You might agree to authorize your architects and engineers to prepare plans for the buildout to accommodate the tenant’s needs and severe time constraints. After all, you expect the prospective tenant to sign your lease. But if the tenant disappears after your architects and engineers prepare the plans, you’ll be burned by that problem.

Especially if you’ve had a hard time filling that space, you might be hesitant to push the tenant to do anything it doesn’t want to. But remember that, when a tenant is up against time constraints, it gives you the leverage you need to protect yourself. So try to not start the architectural and engineering plans process without a lease—but if you must, draft the indemnification agreement, in the form of a letter agreement. A tenant that needs the space built out quickly might agree to sign an indemnification agreement covering the cost of the architectural and engineering plans, making things painless for you.

Find Solution to Pressing Problem

So how should you go about drafting your indemnification agreement? Like our Model Agreement: Avoid Paying for Tenant’s Unused Architectural and Engineering Plans, yours should be in the form of a letter agreement and include the following eight key points.

Key Point #1: Refer to tenant’s request for plans. Make it clear in the indemnification agreement that the prospective tenant asked you to prepare the architectural and engineering plans before it signed the lease [Agr., par. 1]. This way, the prospective tenant can’t justify withholding its reimbursement by claiming that you needlessly incurred costs for something it didn’t want.

Key Point #2: Set deadline for lease signing. You will most likely want the prospective tenant to complete the deal and sign the lease as soon as possible. How long should you give a tenant to sign the lease? Giving a prospective tenant 30 days is fair. Expect strong prospective tenants to ask for more time, though [Agr., par. 2].

Key Point #3: Set deadline for reimbursement. If the prospective tenant doesn’t sign the lease by the deadline, state that it must reimburse your architect’s or engineer’s costs for preparing plans for the space. Since you will want a quick reimbursement, give the prospective tenant a short deadline to pay those costs—for example, within 10 days after getting your bill [Agr., par. 2].

Key Point #4: Require tenant to give security deposit upon signing agreement. Require the prospective tenant to give you a security deposit when it signs the indemnification agreement [Agr., par. 2]. The agreement is intentionally silent on what you should do with that security deposit. That is because your lease deal will determine what happens to the security deposit.

If the signed lease states that you will be entirely responsible for all buildout costs, you will have to refund this security deposit to the tenant. If the signed lease makes the tenant responsible for repaying some or all of your buildout costs, you would apply the security deposit to the tenant’s share of those costs. You would refund any excess to the tenant or the tenant would pay any deficiency.

Some strong prospective tenants may require you to agree that the security deposit will “cap” the tenant’s share of the cost of the architectural and engineering plans. Then you would be solely responsible for paying anything above that cap. Suppose the security deposit is $10,000, but the plans cost $15,000. You would apply the security deposit to the first $10,000, but, unfortunately in this situation, you would be solely responsible for the remaining $5,000.

Practical Pointer: If you’re unsure about how much the prospective tenant should pay as a security deposit, ask your architect and engineer for a cost estimate of their plans and use that estimate when calculating the amount of the security deposit.

Key Point #5: State that agreement is not lease. State that the indemnification agreement doesn’t amount to a lease or an offer or option to lease, or require you to reserve space for the prospective tenant [Agr., par. 3]. The indemnification agreement is meant only to obligate the prospective tenant to pay your architectural and engineering plan costs—nothing more.

Key Point #6: State that you are not required to rent space. Make the prospective tenant agree that you are not required to rent the space to it until it signs your lease [Agr., par. 3].

Key Point #7: Require reimbursement of enforcement costs. To protect you further, require the prospective tenant to reimburse your costs to enforce the indemnification agreement if the prospective tenant refuses to follow the agreement’s terms [Agr., par. 3].

Key Point #8: Get prospective tenant’s signature. It’s essential that the prospective tenant sign the indemnification agreement. You can’t enforce the indemnification agreement unless you have proof that the prospective tenant agreed to it [Agr., par. 4].

Don’t Let Tenant Shift Costs Based on Fault

The big question for each deal is whether the tenant will accept the indemnification agreement. If it does, be prepared for the tenant to try to limit its reimbursement obligation to those situations where it causes the lease deal to fall through. It may argue that if the lease falls through because you dropped the ball, it shouldn’t have to reimburse the architectural and engineering plan costs.

Giving in to this argument could lead to disputes over who actually dropped the ball on the lease deal, thus delaying your reimbursement. If a prospective tenant is adamant, remind it that you don’t typically start the plans process before a tenant signs its lease; you’re agreeing to start the plans process to accommodate this prospective tenant’s time constraints and, therefore, the prospective tenant should bear the risk if the deal falls through—for any reason.