Legal Corner
by Michael Garner

CONSTRUCTION OF TENANT IMPROVEMENTS

Landlords seldom turn over leased premises to tenants which are ready for immediate use and occupancy. Tenants typically need to make improvements to the spaces before they can open for business. The landlord should supervise the construction process carefully, to reduce the likelihood of issues arising during a potentially problematic period.

Tenants can hire a contractor to start construction, and then hit a snag. A worst case scenario would be one where construction is partially complete, the contractor and its subs have not been paid, adjacent tenants are complaining about the disruption of their businesses, a shopper has been injured while walking by the construction site, and the contractor has quit the job and filed a lien against the property.

First, the only good news in this situation is that very rarely can the contractor file a lien which attaches to the owner’s interests in the property; the lien is only valid against the tenant’s leasehold interest. If the lease is terminated, the lien against that interest also disappears. A landlord’s interest is in jeopardy or subject to a lien when the lease requires the tenant to improve the property. This author’s experience is that courts rarely interpret commercial leases as "requiring" the tenant to make the improvements, a judge more often views the lease as an agreement by which the landlord agreed to do some work and the tenant agreed to do the rest.

The injured shopper is probably the most major concern, as injuries and the legal costs of defending a claim can be substantial, as well as consuming considerable amounts of owner and management time. The way to protect against this is to ensure before construction begins that the tenant and its contractor have implemented appropriate insurance coverage and that the owner and property manager are named as additional insureds. The scope and extent of insurance coverage should be reviewed and approved by the insurance agent of the owner or property manager.

The dispute between the tenant and its contractor may be due to the contractor’s experience and/or reputation. All leases should require that the tenant inform the landlord or property manager of its contractor’s qualifications before construction begins. The landlord should confirm that the contractor is registered, licensed and bonded. Much of this information is now available through the websites maintained by the Washington State Department of Licensing.

The lease should also require that plans for the proposed improvements be reviewed and approved by the landlord. This is to ensure they are complete and thorough, sensible, readily comprehensible and understandable, and not likely to give rise to disputes between the contractor and tenant as to the scope and quality of the improvements to be made. Many leases now provide that the landlord’s architect review and approve the proposed plans and specifications at the tenant’s expense.

The disruption to adjacent tenants must be carefully considered. In the absence of a contractual provision, one tenant is generally not liable to other tenants for disruption of business. Consequently, the neighboring tenants look to the landlord to correct the situation and as a potential deep pocket for financial losses which they claim to have suffered from the disruption. A representative of the landlord should monitor the construction as it progresses, to ensure the work is being completed in a timely manner, and that the contractor and tenant are taking all reasonable steps to ensure timely completion, minimize disruption of other tenants’ businesses, and follow appropriate safety procedures.

In many cases the landlord has an allowance to pay or reimburse the tenant for a portion of its tenant improvement costs. Each time the tenant submits an application for payment, the landlord should obtain lien waivers from the contractor and all of its subcontractors for work performed to date. This also provides an opportunity to interact with the contractor, and determine how matters are proceeding and if any difficulties or problems have occurred or are anticipated. Close supervision of the construction from the planning stages through completion is most likely to ensure the project will be completed on time, on budget, and without additional headaches for the landlord. Although the tenant is ultimately responsible for the supervision, a prudent landlord monitors construction to act as a "second set of eyes" and ensure the tenant complies with its lease obligations.