Get Six Vital Protections if You Make TIA ‘Progress Payments’

April 30, 2007

As an owner, it is common to provide a tenant improvement allowance (TIA) to help a tenant in your office building pay the cost of its buildout work. Ideally, you will want to provide the TIA only after the tenant has finished building its improvements and paid its share of the cost. That way, you get to keep your money—and earn interest on it—for a longer time. You also avoid sinking money into improvements that may never be finished if the tenant lacks the money to pay its share.

As an owner, it is common to provide a tenant improvement allowance (TIA) to help a tenant in your office building pay the cost of its buildout work. Ideally, you will want to provide the TIA only after the tenant has finished building its improvements and paid its share of the cost. That way, you get to keep your money—and earn interest on it—for a longer time. You also avoid sinking money into improvements that may never be finished if the tenant lacks the money to pay its share.

The tenant, on the other hand, will want you to pay the TIA up front. It may be nervous about your ability to pay the TIA and won't want to go out of pocket to pay its contractors if it can get the money from you.

A popular compromise in this situation is for you to agree to make conditional “progress payments”—that is, partial payments of the TIA over the course of the buildout. Here is how the compromise should work: Every month or so during the buildout, the tenant will apply to you for a progress payment. You will make the progress payment, but only after getting proof from the tenant that the buildout work up to that point has been performed correctly. This procedure will continue until the TIA is used up or the buildout is finished, whichever occurs sooner.

If you agree to this compromise, it is important that your TIA clause protect you, so that you are not forced to make a progress payment when the tenant has not done its buildout work correctly or doesn't deserve a payment. Therefore, CLLI, with the help of New York City attorney Nancy Ann Connery, will give you a checklist of six protections to include in your TIA progress-payments clause. We also give you a Model Lease Clause, on pp. 3-4, that includes these protections.

Connery has many years of experience negotiating conditional progress-payment compromises for TIAs, ranging from millions of dollars to less than $5,000, including a recent deal in February 2007. Connery's owner-clients tend to agree to conditional progress payments if the TIA is substantial and the tenant has good financials.

Six Protections to Include in TIA Clause

If you agree to a conditional progress-payments compromise, your lease, like our Model Lease Clause, should include the following protections:

Set Five Conditions for Making Progress Payments

Set five conditions in the TIA clause that must be met before you will make a progress payment (excluding the final progress payment) of the TIA during the tenant's buildout:

Tenant can't be in default. The tenant can't be in default of the lease when a progress payment is requested and due, says Connery [Clause, par. a(i)(A)]. Often, a negotiation ensues about whether the default must be limited to a monetary or material nonmonetary default, and whether the payment should be held up only if the default isn't cured within the applicable cure period, she says. Connery likes to suspend the tenant's right to payment until the default is cured, because it gives the tenant a strong incentive to cure.

No mechanic's lien is filed. No outstanding mechanic's lien can be filed against you, the tenant, the space, or the building, says Connery [Clause, par. a(i)(B)].

Tenant must submit required documents. Connery recommends that you require the tenant to give you:

  • Requisition for payment. The requisition must cover services performed and materials supplied for the period covered by the last payment of the TIA, notes Connery. And the tenant must not have previously requested payment for those services and materials [Clause, par. a(i)(C)(1)].

  • Architect's certificate. This certificate should confirm that the portion of the buildout work for which the tenant is applying for payment has been completed as required by the plans and specifications you previously approved [Clause, par. a(i)(C)(2)].

  • Itemized bills. The tenant should give you itemized bills from its architects, consultants, contractors, construction managers, engineers, and suppliers, relating to the portion of the buildout work for which the tenant is seeking payment. If the tenant has already paid those bills and wants reimbursement, the tenant should give you those bills marked “paid” [Clause, par. a(i)(C)(3)].

  • Mechanic's lien releases. If the tenant previously applied for and received progress payments to pay its contractors and subcontractors for the cost of materials, services, and work previously supplied, require the tenant to submit mechanic's lien releases from those parties, confirming that the materials, services, and work have been paid for [Clause, par. a(i)(C)(4)].

Tenant must give you adequate time to review documents. Build in some time—for example, 30 days—after you get the documents from the tenant before you have to make a payment, advises Connery. This way, you will have time to review the tenant's documents and make sure they are in order [Clause, par. a(i)]. But you should be flexible on the timing if the tenant needs a quicker response time, she adds.

You are not obligated to make more than one payment a month. Don't make more than one progress payment in a calendar month, says Connery. Set up the procedure this way: You will make a progress payment within 30 days after you get the tenant's requisition and documents, but only if the tenant delivers them to you by the 10th day of a month. If the tenant delivers them after the 10th day, it must wait to get paid until the second month after the month it submits the requisition. [Clause, pars. a(i) and a(ii)]. This will allow you to review the documentation orderly and efficiently.

Example: The tenant delivers its requisition form and documents to you on May 5. If the documents are in order, you must make a progress payment by June 4. The tenant delivers another requisition form and documents on May 20. Ordinarily, you would have to pay the tenant within 30 days, by June 19. But because you already made a payment in June, the tenant must wait until July to get the progress payment.

If the tenant objects to the delay, consider paying the tenant within a shorter period of time (for example, 15 days after you get the required documentation), says Connery. But make sure you are not required to make more than one payment a month, she adds.

Once these conditions are met, you will make the progress payments, at the tenant's option, either to the tenant's architects, consultants, construction managers, contractors, engineers, and suppliers, if the tenant has not paid them yet. Or, if the tenant has already paid those parties, you will make payments directly to the tenant, says Connery [Clause, par. a(iii)].

Withhold Portion of Progress Payments for Final Payment

Don't make the final progress payment without proof that the buildout work—that is, the alterations and improvements the tenant has made to prepare the space for its initial occupancy (called “Initial Alterations” in the Model Lease Clause)—has actually been done correctly and legally, says Connery. If you pay 100 percent of the tenant's costs throughout the buildout, the tenant may drag its feet in getting you the final building department signs-offs, “as built” plans, and required permits and certificates. You could end up paying out the full TIA for work that is incomplete or illegal.

To prevent that situation, have the lease give you the right to withhold a set percentage—for example, 10 percent—from each progress payment you make throughout the buildout, says Connery. Therefore, instead of making a progress payment covering 100 percent of the tenant's costs during any payment period, you will be required to make a payment that is less than 100 percent—for example, 90 percent—of the tenant's buildout costs, she says [Clause, par. a(i)].

What happens to the money you withhold? All of it will make up your final payment to the tenant, known as the “retainage.”

Example: A tenant incurs buildout costs of $10,000 in March. Your lease requires you to pay only 90 percent of those costs—that is, $9,000—as a progress payment; the other $1,000 is held for the retainage. The tenant then incurs costs of $20,000 in April. Again, you will pay the tenant a progress payment of only $18,000 (90% of $20,000); the remaining $2,000 is added to the retainage.

While you will set five conditions the tenant must meet before getting your progress payments throughout the buildout (see above), the conditions you will set for payment of the retainage will be tougher and more comprehensive. That way, you will be assured that the buildout work is finished correctly and legally, Connery explains.

Set Three Conditions for Paying Retainage

Set three conditions in the TIA clause that must be met before you will pay the retainage to the tenant:

Tenant can't be in default. The tenant can't be in default of the lease when the final payment is requested and due, says Connery [Clause, par. b].

No mechanic's lien is filed. No outstanding mechanic's lien can be filed against you, the tenant, the space, or the building, says Connery [Clause, par. b].

Tenant must submit required documents. Require the tenant to give you the following documents to prove that its buildout work was done correctly:

  • Architect's certificate. This certificate should confirm that all the work you agreed to in the tenant's plans has been substantially completed and done correctly, in accordance with the law and in conformity with the work described in the original tenant plans—which you agreed to. Otherwise, the tenant may have done less work or different, unapproved work. Or the buildout work may not have been performed in compliance with federal, state, or local law [Clause, b(i)].

  • Final “as built” plans. Demand final “as built” plans from the tenant. An as-built plan is essentially a blueprint—prepared by the tenant's architect—that shows the space after the improvements are finished. It will indicate changes to the space, such as new walls, and new or redirected wiring or pipes behind the walls. This plan will be especially helpful when the tenant moves out. If the tenant leaves the improvements in its space, you will want to know about changes to your space before you make any alterations [Clause, b(ii)].

  • Final “sign off” letters, permits. Make sure the tenant gives you copies of any “sign off” letters, letters of completion, and equipment use permits required by law in connection with the buildout work and tenant's equipment installed at the space, says Connery. For example, if the tenant's improvements involved plumbing work, the tenant may need to file a sign-off letter with the local buildings department from the plumber.

    In New York City, if a tenant installs air-conditioning equipment in its space, it must obtain an equipment use permit, she notes. In addition, the tenant will probably need a letter of completion (or similar document) from the local buildings department, she explains, if the work is more than mere cosmetic work [Clause, b(iii)].

  • Final lien releases. Make sure the tenant gives you final and unconditional lien releases from all of its contractors, construction managers, and subcontractors who worked on the buildout. These releases must verify that all bills from the contractors, construction managers, and subcontractors have been paid in full [Clause, par. b(iv)]. Unpaid bills can be a nightmare for you. In many states, a mechanic's lien based on a tenant's unpaid bill can be placed against your property, creating title problems.

Suspend/Terminate Payments if Mechanic's Lien Is Filed Against You or Tenant

Bar progress payments (including the payment of the retainage) if a mechanic's lien is filed against you, the tenant, the space, or your building because of any work allegedly performed for the tenant or materials allegedly supplied to the tenant, says Connery. Don't resume making the progress payment until the lien is discharged by bonding or otherwise, she says. And add that if the lease terminates, your obligation to pay the balance of the progress payments terminates, too, she advises [Clause, par. c].

Make Tenant Pay Deficiency in Buildout Work Cost

If the amount of the TIA is less than the cost of the tenant's buildout work, make sure the tenant is solely responsible for paying the remainder and finishing the buildout work, says Connery [Clause, par. d].

Bar Tenant from Getting TIA Excess

If the amount of your TIA exceeds the cost of the tenant's buildout work, let the tenant know that it is not entitled to the excess, says Connery [Clause, par. d]. You should keep the excess.

CLLI Source

Nancy Ann Connery, Esq.: Partner, Schoeman, Updike & Kaufman, LLP, 60 E. 42nd St., New York, NY 10165; (212) 661-5030; nconnery@schoeman.com.

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PRACTICAL POINTER: Make sure the retainage is big enough to make the tenant feel the pinch, says Connery. We have chosen a 10 percent retainage in our Model Lease Clause, but you may want to revise that figure to fit your situation. Bear in mind that if the amount is too small, the tenant will not have an incentive to give you the documents you need to prove that the buildout work is done. But note that many tenants need the TIA to pay bills. If you withhold too big an amount, you may delay the completion of the buildout work, she warns [Clause, par. b].

PRACTICAL POINTER: Check whether the tenant will need to amend the building's certificate of occupancy before it is allowed to occupy its space, says Connery. If it will, add proof of the amendment to the list of required documents you must get before you will pay the retainage. Also, if you are concerned about the tenant's ability to pay for its alterations, modify the Model Clause to provide that you will pay the TIA proportionally—in legal terms, “in pari passu” with the tenant, says Connery.

It would work as follows: Suppose the TIA is 50 percent of the reasonably estimated cost of the initial alterations. You would pay 50 percent of each requisition amount. Thus, if the tenant has spent $100,000 for improvements in the most recent requisition period, you would pay $50,000 of that amount, holding back the rest as a retainage. The percentage used would be calculated by dividing the TIA by the reasonably estimated cost of construction, Connery adds.

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