Get Reimbursed for Cost of Architectural Plans if Lease Deal Falls Through
Sometimes a prospective office 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 here is the problem: Suppose the lease deal falls through and the tenant disappears after your architects and engineers prepare the plans. You would get stuck paying for plans that may never be used.
Chicago attorney Neil T. Neumark has seen owners get burned by that problem. However, there is a way you can avoid it, he says. Require your prospective tenants to sign an indemnification agreement—in the form of a letter agreement—if they ask you to prepare architectural and engineering plans before they sign your lease.
Neumark just encountered a situation where the indemnification agreement became the solution to a pressing problem. The tenant needed space built out in an office building by the end of January 2007, but the owner was hesitant to start the architectural and engineering plans process without a lease. Because the tenant needed the space built out quickly, the tenant agreed to sign an indemnification agreement covering the cost of the architectural and engineering plans.
With that agreement in place, the owner immediately started the plans process. With Neumark's help, we will give you eight points to cover in the indemnification agreement to prevent you from getting stuck with the bill for unused architectural and engineering plans if your lease deal falls through. And we will give you a Model Letter Agreement, on p. 4, that includes those eight points and you can adapt to your situation.
What to Say in Indemnification Agreement
Your indemnification agreement, like our Model Agreement, should cover the following eight points:
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, says Neumark [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, he explains.
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, says Neumark. How long should you give a tenant to sign the lease? Neumark suggests giving a prospective tenant 30 days. Expect strong prospective tenants to ask for more time, adds Neumark [Agr., Par. 2].
Set deadline for reimbursement. If the prospective tenant does not sign the lease by the deadline, state that it must reimburse your architect's or engineer's costs for preparing plans for the space, Neumark explains. Since you will want a quick reimbursement, Neumark suggests that you give the prospective tenant a short deadline to pay those costs—for example, within 10 days after getting your bill [Agr., Par. 2].
Require tenant to give you security deposit upon signing agreement. Require the prospective tenant to give you a security deposit when it signs the indemnification agreement, advises Neumark [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, notes Neumark. 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 you would be solely responsible for the remaining $5,000, he warns.
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Practical Pointer: How much should the prospective tenant pay as a security deposit? Ask your architect and engineer for a cost estimate of their plans, advises Neumark. You can use that estimate as the amount of the security deposit.
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State that agreement is not lease. State that the indemnification agreement does not amount to a lease or an offer or option to lease, or require you to reserve space for the prospective tenant, says Neumark [Agr., Par. 3]. The indemnification agreement is meant only to obligate the prospective tenant to pay your architectural and engineering plan costs—nothing more, he explains.
State that you are not required to rent space. Make the prospective tenant agree that you are not required to rent space to it until it signs your lease, says Neumark [Agr., Par. 3].
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, says Neumark [Agr., Par. 3].
Get prospective tenant's signature. It is essential that the prospective tenant sign the indemnification agreement, says Neumark. You can't enforce the indemnification agreement unless you have proof that the prospective tenant agreed to it, he explains [Agr., Par. 4].
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Practical Pointer: Get a prospective tenant to sign an indemnification agreement to reimburse your architectural and engineering costs as soon as it asks you to prepare them—and certainly before you give the architect or engineer the go-ahead to work on plans, Neumark says.
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Will Tenants Accept Indemnification Agreement?
In Neumark's experience, prospective tenants typically will agree to this indemnification agreement. However, the prospective tenant may 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 should not have to reimburse the architectural and engineering plan costs.
Try not to give in to this argument. Doing so could lead to disputes over who actually dropped the ball on the lease deal, thus delaying your reimbursement, says Neumark.
If a prospective tenant is adamant, remind it that you don't typically start the plans process before a tenant signs its lease, he says. You are agreeing to start the plans process to accommodate this prospective tenant's time constraints. Therefore, the prospective tenant should bear the risk if the deal falls through, for any reason.
CLLI Source
Neil T. Neumark, Esq.: Principal, Schwartz Cooper Chartered, 180 N. LaSalle St., Ste. 2700, Chicago, IL 60601; (312) 845-5402; NNeumark@schwartzcooper.com.