How to Protect Yourself if You Can't Deliver Office Space When Lease Starts

There may be times when you simply can't deliver an office space to a new tenant on or before the lease's “commencement date” (that is, the date the lease starts). For instance, the old tenant may be holding over in the new tenant's space. Or you may not have started the construction work because a government agency still hasn't issued the required permits. Or a fire or other casualty may have badly damaged the space.

Whatever the reason for the delay, the new tenant may be irate if it can't move into its space by the commencement date and want you to pay for any losses it suffers as a result. Among other things, it could lose business income, have to store its inventory, or pay a higher rent to hold over in its old space. And if it must move to a temporary space elsewhere, it could get stuck with additional moving expenses, such as the costs of moving telephones and computer systems.

A typical office lease may not adequately protect you in this situation. In fact, if you can't deliver a space by the commencement date, the lease may say that you're in default. That means a court could hold you responsible for the new tenant's losses—even if you had no control over the cause of the delay. Plus, you could lose the new tenant.

To help you guard against this outcome, add three protections to your office lease, advise New York City attorney A. Barry Levine and Chicago attorney Richard S. Rosenstein. But expect a strong tenant to demand some kind of remedy if you can't deliver the space on time. We'll tell you how to negotiate four possible remedies with a tenant. There's a Model Lease Clause on p. 3 that you can adapt and use that includes the three protections and four tenant remedies.

Include Three Protections

If you can't deliver a space by the commencement date, make sure your lease includes the following three protections, say Levine and Rosenstein:

* You're Not Liable to Tenant if You Can't Deliver Space

Your best protection is to avoid all responsibility for any of the tenant's potential losses. To do that, state in the lease that you're not liable to the tenant if you can't deliver the space by the commencement date, say Levine and Rosenstein. This protection should be nonnegotiable. You can't afford to risk any liability for the tenant's losses, they warn [Clause, par. a].

* Tenant Stays on Hook for Lease

Make sure the lease says that your inability to deliver the space by the commencement date won't void the lease, says Levine. You want to hold the tenant to the lease—no matter how long it takes for the space to be ready, he points out [Clause, par. a]. Otherwise, you could spend a lot of time and money to finish improvements quickly or force a holdover tenant out, only to find that the new tenant went elsewhere, warns Levine.

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Practical Pointer: Check whether your state gives the tenant a right to cancel the lease or collect damages if you don't deliver the space on time, says Levine. If it does, have the tenant waive that right in the lease so it doesn't override your lease protections, he says.

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* Term Isn't Extended

State in the lease that late delivery of the space doesn't mean the lease term is extended, says Levine [Clause, par. a]. Otherwise, if you're delayed in delivering the space, the tenant will most likely demand that you postpone the lease's expiration date by each day past the commencement date that you haven't delivered the space. This protection is especially important for you if you'll need to make the space available to another tenant on the lease's original expiration date.

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Practical Pointer: Bear in mind that, in some cases, you may want to extend the term to ensure that you'll get fully reimbursed for all of your up-front lease costs, says Rosenstein.

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Negotiating Tenant Remedies

Expect most tenants to object to the possibility of being left dangling for an indeterminate time, with you neither obligated to release them from the lease nor responsible for paying their damages. If a tenant has some bargaining power, it's likely to insist on one or more remedies if it must wait for its space. Here are four popular remedies that a tenant may demand and some tips on how to negotiate them. A tenant may seek one or more of these remedies for its lease. Choose the remedy (or remedies) that works best for your situation and takes into account the tenant's current business objectives and needs, advises Rosenstein.

* Rent Credit

A tenant may ask you to compensate it for your failure to deliver the space on time. Instead of agreeing to fork over money to the tenant, say you'll give it a credit against its base rent, says Levine. Set the credit at one day's base rent for each day after the commencement date that you haven't delivered the space, he notes.

Example: The lease's commencement date is June 1, 2006. You agree that the tenant will get a one-day rent credit each day after the commencement date that you haven't delivered the space. You deliver the space on June 15, 2006. You give the tenant a credit of one day's rent for each day from June 2, 2006, through June 14, 2006. The tenant gets 13 days of free rent.

But bar the tenant from getting a rent credit for any day of delay that it caused (for example, the tenant waited three days to give you the plans and specifications you needed to complete the construction work on time), says Rosenstein. Also, don't give a rent credit for delay caused by an event beyond your control (also known as a force majeure event), he adds. In neither of those situations are you at fault for failing to deliver the space, so the tenant shouldn't benefit from those delays, says Levine [Clause, par. b, opt. #1].

A very strong tenant, such as a large law firm, may want stiffer penalties if the delay goes on too long. It may demand that you give it a rent credit of two days' base rent if you haven't delivered space by a set date—say, 30 days—after the commencement date. The increased rent credit would last each day beyond the set date until you deliver the space, Levine notes.

Example: Assume the same facts as above, except the one-day credit increases to a two-day rent credit if you haven't delivered the space by July 1, 2006. You deliver the space on July 15, 2006. Each day from June 2, 2006, through June 30, 2006, the tenant gets a credit of one day's rent, for a total of 29 days' free rent. Each day from July 1, 2006, through July 14, 2006, the tenant gets a credit of two days' rent, for a total of 28 days' free rent (14 days x 2). Altogether, the tenant gets 57 days of free rent (29 days + 28 days).

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Practical Pointer: You may have no choice but to give in to this double rent credit if the tenant threatens to walk away from the deal, says Levine. But make sure that the tenant doesn't get a double rent credit for any days of delay caused by the tenant or a force majeure event, he says.

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* Term Extended

In this remedy, you agree to give up your right to not extend the lease term—if you hadn't already determined that you wanted a longer term. Instead, you agree to extend the lease term by one day for each day of delay you can't deliver the space by the commencement date. Here too, make it clear that any days of delay caused by the tenant or a force majeure event don't count, says Rosenstein [Clause, par. b, opt. #2]. This way, the tenant gets to stay in the space for the original amount of time bargained for. But don't be surprised if the tenant wants to combine this remedy with the rent credit remedy, so that it doesn't pay rent for the delay period, plus it gets the full length of the lease term, he notes.

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Practical Pointer: If the lease gives the tenant flexibility to renew its lease or if the tenant planned to stay at your space only for a set amount of time, the tenant may not want you to extend the term and force it to stay in the space longer than it had intended, says Rosenstein. That's why it's important to understand the tenant's business objectives and needs before deciding on which remedy to choose, he notes.

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* Termination Right

The tenant may also request the right to terminate the lease if you can't deliver the space on time. But getting stuck with an empty space won't make either you or your lender happy. Also, in practice, few tenants will want to terminate a lease if a delay occurs, because they'll probably have nowhere else to go. But if you must give a tenant a termination right, include three safeguards in the lease:

Termination right isn't triggered immediately. Don't let the tenant exercise its termination right too quickly. Give yourself a reasonable amount of time after the lease commencement date to deliver the space before the tenant can exercise the termination right, says Rosenstein. To do this, set an outside date (known as a “drop dead date”) by which you must have delivered the space—or the tenant can exercise its termination right.

Picking a drop dead date probably won't be easy, warns Levine. The tenant will want a drop dead date shortly after the commencement date, while you'll want a much later drop dead date. The date that you and the tenant agree to will depend on certain factors. For instance, how much bargaining strength does the tenant have? The stronger the tenant, the nearer the drop dead date will be to the commencement date. And how much work needs to be done at the space? The more work needed, the more likely delays are to occur and more costs that you will have to incur. So a drop dead date should be further from the commencement date.

Also, if the new tenant can make reasonable arrangements to stay in its existing space or has other locations where it can temporarily put employees to work, it might agree to a later drop dead date, notes Rosenstein.

For instance, if you're dealing with new construction for a tenant opening a new business, it might be reasonable to set a drop dead date that's between six months and 12 months after the lease commencement date, says Rosenstein. But if you're making only minor improvements and/or the tenant is a small ongoing business with no place to go if it can't move in on time, you may need to set a drop dead date only two or three months after the termination date, he notes. What is “reasonable” will depend on the specific objectives and needs both you and the tenant have, says Rosenstein.

Tenant gets short period to exercise right. Give the tenant a very short period in which to exercise its termination right—for example, the tenant must send you written notice that it will exercise that right within the five days or 10 days immediately following the drop dead date. This way, the tenant must act quickly or lose its termination right. And you know promptly that you may need to find a new tenant and stop spending time and money preparing the space.

You get grace period before lease terminates. Don't let the tenant terminate the lease immediately when it notifies you it's exercising its termination right. Get at least 30 days before the lease terminates, advises Levine. And make it clear that the lease won't actually terminate if you substantially complete your work and give the tenant the space before the 30-day grace period ends. This protects you if, say, you've completed 95 percent of a custom buildout when the tenant terminates the lease. The 30-day grace period gives you the opportunity to finish the job before the lease terminates, he says.

Also, make sure you extend the grace period for each day of a delay caused by the tenant or a force majeure event, advises Rosenstein [Clause, par. b, opt. #3].

Example: The lease sets a 30-day grace period if the tenant terminates it. The tenant causes a three-day delay before the drop dead date by refusing to release its plans and specifications. The grace period is extended to 33 days.

* Rent-Free Temporary Space

As an alternative to the other three remedies, give the tenant the right to move into a temporary space at your building (or in another building you own) rent free starting on the lease's original commencement date (as extended by a tenant delay or force majeure event). This gives the tenant a place to conduct business if it's forced to leave its current space and you're unable to deliver its permanent space on time. If you agree to this remedy, make sure to add these conditions:

• The tenant must accept the temporary space “as is” so you won't have to fix it up;

• The tenant may not sublet the temporary space to anyone else;

• The tenant must pay its moving costs, so you won't have to; and

• The tenant must vacate the temporary space in broom clean condition within a short time after the permanent space becomes available.

To motivate the tenant to move out of the temporary space when its permanent space becomes available, say in the lease that if the tenant fails to properly clean or vacate the temporary space, then, at your option, such failure would be a default under the lease, advises Rosenstein. Also, the tenant should be deemed a “tenant at sufferance.” That means the tenant will have no rights in the temporary space and you have a legal right to kick it out at any time, as you would with a licensee, he explains. Alternatively, the lease could expressly say that the tenant would be a mere licensee of the temporary space, he adds.

Also, make the tenant pay rent for the temporary space as well as rent for the permanent space, Rosenstein advises. And force it to meet its other lease obligations and be responsible for any damages you incur because the tenant refuses to move out of the temporary space, he adds [Clause, par. b, opt. #4].

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Practical Pointer: Expect a savvy tenant to demand that you pay the cost of its move from the temporary space to the permanent space, since your failure to deliver the permanent space is the reason for its double move, notes Levine. You may have to give in to this demand.

CLLI Sources

A. Barry Levine, Esq.: 320 E. 23rd St., New York, NY 10010; (212) 477-5118; blevine2@nyc.rr.com.

Richard S. Rosenstein, Esq.: Rosenstein Law Offices, P.C., 55 East Monroe St., Ste. 3850, Chicago, IL 60603; (312) 263-1686; richard@prop-law.com.