Strike Progress Payment Compromise for Shared TIA Expenses

It’s not uncommon for tenants to plan to spend more than you’ve agreed to pay for a tenant improvement allowance (TIA). Owners have a dual goal when providing a TIA: It entices tenants to lease the space and, by being updated, the space is more valuable overall. But generally it takes some time—several weeks to several months—to complete a buildout in a commercial space. Ideally, the tenant would complete its improvements, the space would be ready to go, and you would reimburse it for your share. But a tenant, and especially one that doesn’t have deep pockets, could be nervous that you won’t come up with your share of the cash in the end. You could give the tenant the lump sum of the TIA before the project starts, but in that scenario, you risk a wrench being thrown into the works: The tenant could run out of money during the course of the buildout, but you would’ve already sunk your money into improvements that may never be finished unless or until the tenant comes up with more funds, and you could ultimately be the party that’s forced to finish the space.

A popular compromise for an owner in this situation is to agree to make conditional “progress payments”—that is, partial payments of the TIA over the course of the buildout. Every month or so during the buildout, the tenant will apply to you for a progress payment. You’ll 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 pattern will continue until the TIA is used up or the buildout is finished, whichever occurs sooner.

But what happens if the tenant hasn’t done its buildout work correctly or doesn’t deserve a payment? If you agree to a conditional progress-payments compromise, use the protections like those in our Model Lease Clause: Negotiate Six Protections If You Pay TIA in Installments, below, for the TIA clause in your lease, so that you’re not forced to make a progress payment when the tenant doesn’t deserve it.

Protection #1: Set Conditions for Payment

Set the following conditions 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 [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. 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 [Clause, par. a(i)(B)].

Tenant must submit required documents. Require the tenant to give you four items:

Requisition for payment. The requisition must cover services performed and materials supplied for the period covered by the last payment of the TIA. 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. 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.

You’re not obligated to make more than one payment a month. Don’t make more than one progress payment in a calendar month. 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 efficiently and in an orderly way.

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). But make sure you are not required to make more than one payment a month.

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 [Clause, par. a(iii)].

Protection #2: 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, also known as “initial alterations,”—has actually been done correctly and legally. 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. 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 [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.

Protection #3: Set Conditions for 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 [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 [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 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 [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.

Protection #4: Suspend/Terminate Payments If Mechanic’s Lien Is Filed

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. Don’t resume making the progress payment until the lien is discharged by bonding or otherwise. And add that if the lease terminates, your obligation to pay the balance of the progress payments terminates, too [Clause, par. c].

Protection #5: 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 [Clause, par. d].

Protection #6: 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 [Clause, par. d]. You should keep the excess.