Tenant Improvement and Build-Out Disputes

Where these disputes come from

Most commercial leases of raw or second-generation space include a work letter. It says who builds what, who pays, when the space must be delivered and in what condition, and what happens when the schedule slips. The tenant improvement allowance is the landlord's contribution, usually stated per square foot, toward the tenant's build-out. Disputes arise in four patterns: the landlord will not pay or pays late; the landlord delivers the space late or in the wrong condition; the tenant's contractor is not paid and liens the property; and the parties disagree at the end of the lease about who owns the improvements and whether the tenant must remove them.

Texas has no statute governing allowances or work letters. The Property Code's commercial lease provisions address lockouts, deposits, mitigation and the assessment of charges, none of which decides a build-out fight. The lease controls, and the general rules of Texas contract law fill the gaps, as explained in commercial lease disputes in Texas.

The landlord will not pay the allowance

Read the conditions. A typical work letter makes the allowance payable only after the tenant delivers some or all of the following: final unconditional lien waivers from the general contractor and subcontractors, a certificate of occupancy, as-built drawings, proof that the work matched the approved plans, confirmation that the tenant is open and paying rent, and a written request submitted by a stated deadline. Many work letters also provide that the landlord may withhold the allowance while the tenant is in default under the lease, and that any unused portion is forfeited after the deadline.

If the tenant satisfied every condition, the landlord's refusal is a breach of the lease and the tenant may sue for the allowance as damages, with attorney's fees under the lease or under Chapter 38 of the Civil Practice and Remedies Code for a breach of a written contract. If a condition was missed, the analysis shifts to whether the condition was waived (for example, by the landlord's course of dealing or by paying earlier draws without the paperwork), whether the deadline was extended in writing, and whether the missing item was material. Courts enforce clear conditions precedent, so a tenant that missed a submission deadline has a hard case unless the lease language or the landlord's conduct gives it a path.

Can the tenant take it out of the rent?

Only if the lease allows it. Texas does not imply a right for a commercial tenant to withhold or offset rent against amounts the landlord owes, and most leases contain an express promise to pay rent without deduction or setoff. Some negotiated work letters do give the tenant an offset right if the landlord fails to pay the allowance within a stated period after the conditions are met, sometimes with interest and often capped at a percentage of each month's rent. Where that clause exists the tenant may use it exactly as written. Where it does not, a tenant that unilaterally reduces rent to recover the allowance becomes the defaulting party and exposes itself to late fees, default interest, lockout and eviction under the lease and Chapters 93 and 24 of the Property Code. The tenant's safer course is to pay rent, send written notice of the landlord's breach, and sue for the allowance.

Late or defective delivery

The work letter sets the delivery condition (shell, warm shell, turnkey) and the target date. Well-drafted letters allocate delay. Landlord delay beyond the target usually abates rent day for day or pushes the commencement date; delay beyond a longer outside date may give the tenant a right to terminate and recover its costs. Tenant delay, caused by late plan approvals, change orders or long-lead items the tenant chose, is carved out and does not move the commencement date. Force majeure clauses often extend the landlord's time.

Litigation in this area is a fight over whose delay it was and how the clauses interact. Tenants argue that the landlord's late delivery cost them opening-season revenue, employee wages and marketing; landlords argue that the tenant's plan changes caused the slip and that the lease limits remedies to abatement. Leases often contain a waiver of consequential damages that bars lost profits for either side, so the remedy may be limited to the abatement or termination right the work letter gives. Whether a defective condition at delivery breaches the lease depends on the delivery standard and on any inspection and punch list procedure the tenant was required to follow within a set time after delivery.

Liens from the tenant's contractor

A contractor that builds out a space has a mechanic's lien under Property Code § 53.021 if it worked under a contract with the owner or the owner's agent, contractor or subcontractor. Under § 53.022 the lien extends to the improvements and to each lot of land necessarily connected. When the tenant is the party that hired the contractor, the owner for lien purposes is the tenant, and Texas courts hold that the lien attaches to the tenant's leasehold estate and to the improvements the tenant owns, not to the landlord's fee interest. The lien reaches the landlord's fee only if the landlord contracted for the work itself or the tenant acted as the landlord's agent in ordering it. Courts look at whether the landlord required the work, controlled it, directly paid the contractor or structured the allowance so that the tenant was really building the landlord's improvements. A lease clause saying the tenant is not the landlord's agent helps the landlord but is not by itself conclusive.

Because a leasehold lien is worth little to a contractor, unpaid contractors often file the lien affidavit against the whole property anyway and leave the landlord to sort it out. The lease almost always requires the tenant to keep the property free of liens and to discharge or bond around any lien within a short period, so an unpaid build-out contractor creates a tenant default as well as a title problem. Removal of a lien that overreaches is covered in how to remove an invalid lien from Texas property, and the contractor's own deadlines and rights are in how mechanic's liens work in Texas.

Example

Suppose a Richardson software company leases 15,000 square feet of second-generation office space with a work letter promising an allowance payable in two draws, each conditioned on lien waivers, and a final draw conditioned on a certificate of occupancy and a request made within 180 days after substantial completion. The landlord delivers the space six weeks late because of asbestos abatement; the work letter abates rent day for day for landlord delay but excludes delay caused by tenant plan changes, and the tenant did change the ceiling plan twice. The tenant finishes, opens, and submits its final request on day 195 with conditional rather than unconditional waivers because its general contractor is in a dispute with the electrical sub. The landlord refuses the final draw, citing the deadline and the waivers. The electrical sub then files a lien affidavit against the building. The tenant's case for the allowance depends on whether the landlord's acceptance of late paperwork on the first two draws waived the deadline; the tenant's abatement claim depends on how much of the six weeks is attributable to its own plan changes; and the landlord's position on the lien depends on showing that the tenant alone contracted for the electrical work, so the lien reaches only the leasehold.

Who owns the improvements at the end

Leases typically provide that improvements become the landlord's property on installation, except for the tenant's trade fixtures and equipment, and that the landlord may require the tenant to remove specialty improvements (internal stairs, raised floors, vaults, supplemental HVAC) and restore the space at the tenant's cost. Fights at move-out turn on which items are trade fixtures, whether the landlord gave the removal notice the lease requires and by what deadline, and whether a restoration obligation that was never mentioned at the time of approval can be imposed years later. The lease's plan approval letters are often the deciding evidence.

Evidence to keep from day one

• The signed lease, the work letter and every exhibit, with all approved plans and change orders.
• Delivery and acceptance correspondence, punch lists and dated photographs of the space at delivery.
• The construction schedule, with each delay and its stated cause recorded when it happened.
• Every draw request, the landlord's response and the paperwork submitted with it.
• Contracts, pay applications and lien waivers from the general contractor and each subcontractor.
• Any recorded lien affidavit and the notices that preceded it.

When to involve a litigator

Before withholding rent, before refusing a draw, and the day a lien affidavit is recorded, since each of those steps changes which side is in default. A claim for breach of a written lease must be filed within four years under Civil Practice and Remedies Code § 16.004. Tina Wysk represents landlords and tenants in build-out, allowance and lien disputes in Dallas-area courts through the firm's real estate litigation practice.