What is an Alteration Agreement?
An alteration agreement is a legally binding contract between a landlord and a tenant, or a landlord and a third party (in most cases the tenant’s construction contractor). The contract requires the tenant to seek permission from the landlord before making any alterations to their property and to agree on a repayment mechanism for the alterations at the end of the term (often at a rate of eleven percent per annum, assuming the alterations have been approved by the landlord and the work completed to the landlord’s reasonable satisfaction).
Typically such an agreement will be proposed to a tenant on the terms of a property lease where the lease requires a third party review and approval (in many cases the landlord) prior to making the works. The agreement sets out the conditions under which such works are permitted, including the obligations to any third party and the landlord’s rights to review and approve the plans for the proposed works.
Where a tenant is looking to make a significant improvement to a property (such as a major restaurant refurbishment), be it structural or otherwise, typically the landlord will look for an alteration agreement to be entered into. The landlord has limited statutory protection in these situations, so it will often require an alteration agreement to set out the condition under which the works can be carried out, what the tenant does with the assets and whether the landlord can claim them at the end of the term .
An alteration agreement can be vitally important for both the landlord and the tenant when it comes to reviewing the boundaries of the landlord’s consent and the tenant’s right to improve the premises. Often the tenant will want to extend its lease in order for the alterations to be amortised (in some cases it will have already sought a long lease from the landlord in return for paying a premium or higher rent). It may also seek a rolling or fixed rental concession, which insurers may require.
The terms of the alterations will be carefully drafted by the landlord’s solicitors in order to avoid any future ground rent and code issues on the part of the landlord’s insurance cover. Only once the tenant is happy with the terms and accepts its capital investment will the landlord allow the works to be completed with the right to value the works in accordance to the RICS Code of Measuring Practice, recognising the amount paid for the works and any professional fees incurred.
An alteration agreement is vitally important as it helps regulate the relationship between the landlord and the tenant, particularly where a tenant looks to carry out a temporary or a permanent alteration to a property.
Legislated Requirements for Alteration Agreements
An alteration agreement must satisfy certain legal requirements as a prerequisite to being enforceable against a party. The most significant of these requirements, and the one which most often gives rise to potential disputes, is that a lessor must expressly reserve its rights against the lessee in order for such rights to be preserved upon any subsequent assignment of the lease. The reserved right must be sufficient to give the benefit of the bargain upon an assignment. For example, if the lease calls for a reduction in rent in exchange for a tenant’s concession regarding a term of the lease, the reserved right should specify the particular reduction owed in a particular circumstance in order to clearly preserve the right when the lease is assigned. Without this particularity, a misleadingly optimistic picture of the remaining obligations under the lease may be left if the lessor later seeks to rely upon a general reservation of its rights. See Chinachem Charitable Foundation Fund v. Nash, 251 P.3d 588 (2011).
Other useful legal requirements which may help prevent breach of contract litigation include establishing the following: (i) that the altered lease terms are enforceable without further consideration (this typically requires a good-faith finding of consideration); (ii) that the lessor has negotiated the agreement; and (iii) that the lessor actually signs the alteration agreement.
Common Circumstances That May Require Alteration Agreements
The necessity of an alteration agreement arises in a variety of cases. Tenants may wish to renovate their premises to provide a more effective use of space or to modernize. Expansion of the tenant’s business in the premises may make additional space desirable or necessary. The premises may be expanded by way of new construction of an interior space, an addition to the premises or perhaps by the relocation of an exterior core structure such as an entry way. Expansion of business may also involve the need for additional facilities both permanent and temporary. Permanent facilities can include, for example, the installation of a boiler, pad or other essential permanent items like walk-in refrigeration, duct work for exhaust systems or waste disposal. Temporary or periodic uses may include trailer rentals for seasonal activity at outdoor centers, which exist for a few months each year, or the need for warehouse or staging facilities for general inventory. The latter types of facilities may require the use of outside perimeter areas that may be considered common areas of the building or center such as parking lots or driveway areas. In many instances the ability to expand spaces can impact other tenants in the leased premises or on adjoining premises in a center. Perhaps a neighboring tenant wishes to install an over-sized sign which will block the view of a tenant’s existing sign. The existing tenant may have lease restrictions on this permitted signage scope or location. There may be restrictions on the maximum square footage for utility cores and, if exceeded, the entire center could be rendered in default. Failure to address these issues could result in tenant default resulting from its expansion and could reduce the value of the center as a rental property.
There is risk in disregarding the need for an alteration agreement whereby a casual expansion is done by contractor or tenant in the absence of a governing agreement between owner and contractor. The owner or landlord could be subject to significant property damage or even personal injury claims which may not be covered by an insurance policy. It is recommended that tenant agreements require the tenant to indemnify the owner or landlord for losses arising out of the negligence of the tenant or its contractor. Of course, complete protection against all such losses can not be assured since certain risks such as earthquake, flood and terrorism are not typically covered under current insurance policies.
Preparing a Proper Alteration Agreement
The most important tip in the drafting of an alteration agreement is to do it early. An alteration agreement does require some considerable negotiation, so the earlier you start the better. At a minimum, the alteration agreement requires the approval of the condominium board and the unit owner. The board may require more information or documentation, and sometimes the board will want to raise fees or restrict sizes before it will approve the alteration. The earlier you start the easier it is to reach an agreement. In some circumstances the board may need the approval of the shareholders of the cooperative as well.
The following are some clauses that should be included in an alteration agreement:
A description of the work which is to be done, including any drawings and plans.
A description of the premises affected by the work. For example, if the alteration is an installation of a central air conditioning system, the premises affected may begin in the unit and include parts of the building as well, such as the roof . The description of premises should be as precise as possible because the declaration or other condominium documents may not provide a clear road map.
The time for the completion of the work. The completion date should not be set too far in the future because the only remedy during the period between the execution of the agreement and the completion of the work is a liquidated damages provision. Liquidated damages, however, become less of an incentive when they are assessed over a long period of time.
The manner of the performance of the work.
The manner of the payment for the performance of the work. For example, the board will want to make sure that the performance bond or check, if any, has been cleared before the commencement of the work. Issuance of a check prior to the work commencing is often referred to as an "ante-dated check," and such checks are often payments for future services to be rendered, which violate the New York State Penal Code Section entitled "Issuing a Bad Check."
Potential Issues and Their Solutions
Alteration Agreements present several potential challenges for both the owner and the contractor.
One challenge is strict compliance with the notice provisions in the Agreement which may require that materials or products be changed or removed prior to installation or that the work be performed at a specific time so that other work can proceed in accordance with the schedule. However, if the work is performed contrary to the Agreement, the owner or architect may still consider the work acceptable. Whether the work is acceptable will determine if the contractor must replace the noncompliant work or whether the owner must pay for the work because it did not comply with the Agreement.
Another challenge arises when an owner requests a change, even if after the contract is signed, and that change is submitted by the contractor in a proposal. The owner’s approval of the change does not waive the prohibition against changes without written Agreement.
Finally, another challenge arises in connection with the acceptance of altered work. The Agreement typically requires the architect’s acceptance of altered work before payment is due. Another issue with acceptance of altered work is material defects and latent defects. The Agreement may require that the contractor submit a warranty for a specific period of time. However, if the alteration does not comply with the architect’s approval, the client may not be liable to pay for that work.
Alteration Agreements in the Context of Property Management
Alteration agreements can have a profound impact on various aspects of property management. First and foremost, they can affect the value of a property. If tenant improvements result in increased sales for a retail tenant, for example, that may increase the value of the property if it were to be sold or refinanced. If a space has been brought up to the maximum fire code due to tenant alterations, for instance, that may enhance the ability of a future tenant to obtain the required fire permits. Alternatively, if the alterations were costly and/or not sufficiently compensated, they may detract from the property value.
Alteration agreements can also influence tenant relations. For example, while most tenants will never attempt to interpret a lease agreement and decide the landlord is not conforming with its obligations thereby justifying an early termination , having a clearly defined right to do so provides a tenant with added security and leverage. Conversely, if a tenant has flexibility to terminate a lease, they will tend to feel more secure if the rent increase provisions are as predictable and reliable as possible.
Finally, alteration agreements provide commercial landlords with a vehicle to consider the future of the building and the overall development of the area. In a lease negotiation, the tenant may be reluctant to incur additional costs for an alteration plan review in an area that is undergoing redevelopment. It may be important to the economics of the deal to build in flexibility for the landlord to recognize the need for an amendment to the alteration provisions due to changing conditions. Such provisions will enable a landlord to decide whether to use its discretion to determine what future alterations will be approved.