Owner Assumed Duty for 'Punch List'

Facts: A utility company signed a lease for an office building that would be constructed according to a building plan between it and the owner. The lease would commence when the building was “substantially complete,” meaning that the building had been constructed according to the agreed-upon plan, with the exception of only minor items that needed repair on a “punch list” that the tenant was responsible for providing after it inspected the construction. The owner was required to make reasonable efforts to complete the punch list items within 30 days of the tenant's moving in.

Under the lease, the tenant's taking possession of the space would mean that, aside from any remaining punch list items: (1) the building and other improvements had been completed in accordance with the building plan; and (2) the premises were in good and satisfactory condition.

After the tenant accepted the building as substantially complete, submitted an eight-page punch list of items in need of repair, and moved into the space, it was notified that the building had been sold and its lease would be assigned to the new owner in 30 days. The punch list deadline expired soon after the new owner took over the lease. At least one repair on the punch list hadn't been performed and caused leaks in the building's foundation.

The tenant asked the new owner to fix the problem and reduce its rent. The new owner repaired the problem, but continued to charge full rent. The tenant sued it for breach of the lease, asserting that the new owner as “successor landlord” assumed the original owner's obligations under the lease—including the duty to complete the punch list items.

A Texas trial court concluded that the new owner had assumed a duty to oversee the completion of the punch list and was responsible for the omitted repair because it had already purchased the building when the punch list repairs were due under the tenant's lease. The court awarded the tenant the cost of the diminished value of the lease. A court of appeals upheld the decision in favor of the tenant, and the new owner appealed again.

Decision: The court reversed the decision of the lower court.

Reasoning: The new owner asserted that it hadn't breached any construction-related duty under the lease because the building's construction was substantially complete before the new owner purchased the property. The new owner contended that, even assuming that construction-related duties required under the tenant's lease still needed to be performed, the assignment of the lease to the new owner cut off any such duties—specifically, completing the punch list. The new owner also argued that when the tenant accepted the building by taking possession of the space, it relieved the new owner of any construction-related duties.

The tenant contended that the assignment shouldn't have affected its rights under its lease, regardless of who owned the building.

The appeals court pointed out that, “Under a build-to-suit lease, the owner wears two hats, functioning as both the tenant's construction contractor and landlord…Under this arrangement, the property owner agrees to construct a building to the tenant's specifications, and the tenant agrees to lease the building for a term sufficient to permit the owner a profit,” the appeals court continued. Although the owner apparently intended to assume only the latter role, the assignment failed to eliminate some lingering construction-related issues, the appeals court determined.

The appeals court also clarified what kinds of damages were available for a tenant in this type of situation. “Once a construction project has been substantially completed, as in this case, the damages for errors or defects in construction are the cost of completing the job or of remedying those defects that are remediable, without impairing the building as a whole,” the appeals court noted.

The issue in the case was whether the construction of the property in the tenant's build-to-suit lease was ever “substantially completed.” When the new owner purchased the property, the tenant was already in possession of the premises and had accepted the building as substantially complete; however, its acceptance was subject to the exceptions contained in its punch list, the appeals court observed. But if those exceptions were capable of being repaired, then that cost would be the appropriate damages for the tenant for the construction-related breach.

The tenant argued, however, that the new owner's repair efforts failed to fix the problem—that even after repairs, the foundation remained unstable—so its damages should be the diminished value of the lease because the foundation problems would be ongoing and it wouldn't have gotten the benefit of the building that it had basically paid for through its lease.

However, the appeals court didn't find the new owner's repairs ineffective. It said that, although it agreed that the new owner had a continuing contractual duty to maintain the foundation, the damages awarded by the trial court jury were inappropriate. That's because the tenant's theory—that it didn't get the building it bargained for, so its damages should be measured by the building it actually got, that is, the difference in value—presumes that the defect couldn't be remedied.

The appeals court determined that the cost of repair is the appropriate measure of damages to remedy an omitted item on a substantially completed building. But because the new owner made the repairs at no cost to the tenant, the appeals court concluded that the tenant hadn't suffered any damages.

• Ashford Partners, Ltd. v. ECO Res., Inc., April 2012