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What Can Go Wrong with Leasehold Improvements?

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Excerpted from the book "Construction Nightmares" from BNi Building News

The tenant improvement work for Worldwide Importers began on Monday morning, and Allen was in fantastic spirits.  His contractor was Rodger Scott, of Happy Tenant Improvement Company:  Rodger’s price was not only rock bottom, but he also drew his own plans.  So Allen called Ivor Judge and ordered him to stop work on the drawings and specifications. 

“But, Allen, we’re almost done.  We’ve filed for the building permit and we’ll have it by the end of the week.” 

“Look, Ivor, I won’t need your plans.  And I won’t need Hyde either.  You guys are too rich for my blood.  I’m getting the job done at half the price and the construction’s already started.” 

“Okay, Allen.  We’ll stop work and send you a bill for all costs to date.” 

“What do you mean?  Your plans are no good to me.  They’re useless.  Why should I pay for something I can’t use?” 

Ivor lost his cool and slammed the phone down.  He immediately called his lawyer and asked him to send a letter to Allen explaining the necessity of paying the bill.  When the lawyer’s letter arrived, Allen sent it on to Phil Quinn, who later advised Allen that it would be better to pay the $4,750 architectural fee than to spend money fighting it and, finally, to lose. 

*****
Allen left his office, walked over to the construction area, and stopped to talk to Rodge.  “Say, Rodge, how did you get the building permit so quickly?  Our architect told me they had to pull strings to get a permit in a week.” 

“Well, we didn’t actually get a permit.  When we work inside a completed building where we don’t have to build exterior walls or the roof we don’t usually get a permit.  It also makes the construction a little simpler, too.  We don’t have to wait around for inspectors to show up.” 

“Oh, I didn’t know you could do that.” 

“Sure, we do it all the time.  It would be difficult for us to get a permit anyway since we don’t have a contractor’s license.  We try to avoid red tape and unnecessary costs whenever possible.  We pass the savings on to our customers.” 

“You don’t have a license?  I didn’t know that.” 

“Didn’t Gary tell you?”  Rodge quickly walked away to help a carpenter move a pile of studs.  He left Allen deep in thought. 

* * *

When Allen got back to his office, Chad Sennet was waiting for him.  Chad was the owner of Barracuda Brokers. 

“Good Morning, Allen.  How’s business?” 

“Okay, Chad.  How’re things with you?” 

“We’re very busy.  The rental market’s starting to come alive.  We’ll be finding you a tenant any day now.  That’s why I’m here:  Our listing expired last week and I have a 90-day extension here for you to sign.” 

“We won’t need it, Chad.  And you can take your For Lease sign with you today when you’re leaving.” 

“Oh?  What do you plan on doing?  Are you going to sign up with a different broker?” 

“No, Chad.  As a matter of fact, we found a tenant ourselves.” 

“Oh?  When did you sign the lease?” 

“Not that it’s any of your damn business, but it was last Monday.  The contractor is already working on the space and the tenant will move in on June 30th.” 

Chad, referring to his file, said, “Our exclusive listing didn’t expire until last Tuesday.  So you owe us our leasing commission.  How long is the lease?” 

“Five years.” 

“Well, five years at $2.00 a square foot for 2,500 square feet is $300,000 gross.  Our commission is $15,000.  You can write me a check right now, if you please.” 

“No, Chad.  You didn’t find us a tenant.  We owe you nothing.  And we didn’t get $2.00 a square foot anyway.  It was a lot less than that.” 

“Well, how much was it?” 

“After a lot of negotiation, we settled for $1.25.” 

“I’m sorry to hear that, Allen.  We could’ve gotten $2.00 easily.  The market is getting a lot stronger.  We made a deal at $2.50 just last week.  Why didn’t you call us?  We could’ve handled the negotiation for you.  We’d do all the credit checks and everything.” 

“I think you’d better leave, Chad.  We have nothing to discuss.”  Allen rose and waited for the broker to leave. 

A few days later, a letter arrived from Barracuda Brokers’ lawyers demanding the payment of the leasing commission.  Allen sent it on to Phil Quinn.  Upon receiving the letter, Phil called Allen with the sad news that the commission would have to be paid.  So Allen sent a copy of the lease to Phil.  Phil calculated the proper commission to be $9,375, which he was able to negotiate down to a more reasonable $8,500.  The reduction almost covered Phil’s fee.
 
Phil also had some questions for Allen about the lease but thought it would be wiser to discuss it some other time. 

*****
Rodger Scott was making exceptionally good progress with the office.  After about two weeks of frenetic construction activity, he told Allen he’d need the paint colors the following day or they wouldn’t be able to finish on time.  He gave Allen some paint chips to select from.  So, Allen called Gary to come in and select the colors.  That afternoon, Gary and his wife, Pearl, arrived to pick colors.  Pearl took charge of the color chips and went to the new office area to discuss them with Rodge.  Allen and Gary remained in Allen’s office.  Allen felt this would be a good time to discuss the still unpaid deposit. 

“Uh, Gary, what about the deposit?  We’re getting close to move-in day and you still haven’t paid the deposit.” 

“Don’t worry about it, Allen.  Two of the biggest banks in the world are behind me.  Don’t you trust them?  Their assets are in the multi-billions.  I’ll get their financial statements for you.” 

“No, Gary.  I don’t need their financial statements.  I just want to see the $12,500.” 

“Nothing to worry about, Allen.  You’ll get it.  In due course.  Banks are very slow you know.  They have to be extremely careful.  They dot all the I’s and cross all the T’s.  You know how it is with banks.  Right, Allen?” 

“I’ve played along with you long enough, Gary.  If that deposit isn’t paid before June 30th, I can’t let you move in.  Understand?” 

“Yeah, Allen.  I understand.” 

Pearl and Rodge reappeared from the new office area.  They were heatedly arguing about the paint colors. 

Rodge summed up his position to Gary and Allen.  “My figure is based on painting everything the same color.  They want 12 different colors.  The want three or four colors in some rooms.  It’ll cost more and we’ll never finish on time.  What do you want me to do, Allen?” 

Gary spoke up, “How much more will it cost, Rodge?” 

“About $1,450.  But it’ll also take more time, so we won’t finish on June 29th.” 

Gary asked, “How much more to finish on time?  Your painters could work overtime.” 

Rodge scribbled some figures on his clipboard.  “About $800 more on top of the $1,450.”

Gary said, “Okay, Rodge, go ahead with it.  I’ll settle up with Allen for it.”  Pearl looked extremely pleased with Gary and shot Rodge a triumphant look.
 
* * *
Two days later, Gary returned to see Allen and to check on the progress of the work.  He went into Allen’s office and announced, “Plenty of good news today, Allen.”  He handed Allen a check for $12,500. 

“Gee, thanks, Gary.”  Allen was grateful and relieved.  He’d been worried that Worldwide Importers might have been a bad idea.  Now everything looked all right. 

“More good news, Allen.  We’re going to need some warehouse space on a permanent basis.  We want you to wall off 3,000 square feet of space that can be locked and we’ll operate our inventory from there.  So, if we can agree on a price, you can add this to our office lease.” 

“Well, that’ll be great, Gary.  How about 60 cents a square foot and another 5 cents to cover the walls we’ll have to build.  That’ll be a total of 65 cents a square foot.” 

“Don’t be ridiculous, Allen.  That’s way too high.  I don’t want to haggle.  So, here’s my top offer.  Take it or leave it.  I’ll pay 35 cents a square foot and I’ll get the walls built.  That’s a lot of money, Allen.  $1,050 per month.” 

Allen was definitely interested, as he had quite a bit more warehouse space than he really needed at the moment.  He knew he’d grow into it eventually, but right now he could use the income. 

“Okay, Gary, you’ve got a deal.  The cheapest warehouse space in town.  And you can increase the deposit by $4,200.” 

“Fair enough.  Give me back the check for $12,500 and I’ll replace it with one for $16,700.”  He then reached across Allen’s desk, retrieved the deposit check, and put it in his inside pocket. 

“I’ll see you tomorrow, Allen, and we can look at the warehouse and mark off my 3,000 square feet.” 

“Can’t you just write another check for $4,200 and leave both checks with me?” 

“No, Allen, I’ll write a new check.  It’ll be a cleaner deal that way instead of two piecemeal checks.  I’m sure our accountants would prefer it that way.” 

*****

Rodger was proceeding rapidly and right on schedule.  It looked like he’d finish on Monday, the 29th of June as promised.  On Friday, the 26th, Allen and Gary were looking around admiring the new offices and watching the painters and electricians.  When Rodger joined them, Allen asked, “Say, Rodge, when is the carpeting coming in?” 

“I don’t know, Allen.  Carpeting isn’t in my contract.” 

“Why not?  Who took it out of your contract?” 

“It was never in my contract.” 

“Well, it was in Hyde’s contract.” 

“I don’t know anything about Hyde’s contract.  All I know is it isn’t in my contract.  It doesn’t show on the drawing.”  He was digging the drawing out of his pocket. 

Gary spoke up.  “Allen, we have to have carpeting.  You better get it lined up or we can’t move in.” 

Rodger issued a warning, “You’ll have to have it done on Sunday, as we’re working tomorrow to finish putting in the ceiling panels and we’ll need all the space again on Monday as that’s our last day for finishing up the job.  We can’t have carpet layers under our feet.” 

Gary observed, “Rodge, it’s kind of dark in here, when’re you going to put the lights and tubes in the fixtures?”

Rodge replied, “They’re not in my contract.” 

Allen went back to his office and started phoning around to see what he could do about carpeting.  The best price he could get was $6,500 on account of it having to be installed on a Sunday.  And the choice of colors was limited to Ocean Chartreuse and Bitter Mauve, as it was now too late to order from their supplier’s warehouse.  Gary chose Ocean Chartreuse since he didn’t have time to confer with Pearl. 

Allen asked Carl to send one of the loading dock crew out to buy a few cartons of fluorescent tubes and incandescent bulbs and to have him stay late on Monday night to install them. 

All the construction was completed on time, the carpeting was installed, and Worldwide Importers moved in.  With all the confusion over the painting, lighting, carpeting, and moving-in, Allen had forgotten about the deposit.  On July 1st, Gary’s first day of occupancy, Allen walked over to Worldwide’s offices and spoke very sternly, “Gary, now I want your deposit check.  Right now.  No more horsing around.” 

“Okay, Allen.  Here it is.”  He casually handed Allen a cashier’s check for $16,700.” 

Allen was surprised at how easy it was.

*****

Points of Law In “What Can Go Wrong With Leasehold Improvements”

The Design/Build Contract
From the standpoint of a project owner, a design/build contract has a one paramount advantage that may in itself and standing alone outweigh a number of less significant disadvantages.  That advantage is that there is only one party responsible for the proper outcome of the construction project.  If there is a problem on the job, the contractor is in no position to blame the owner or the architect.  The contractor is the architect.

The disadvantages of design/build to the sophisticated owner are relatively minor.  A sophisticated owner is in a position to judge the quality of the design and the fairness of the price.  To a project owner like Allen, however, unsophisticated in matters of construction, a design/build contract may present problems.  The design may be inferior.  The design may omit important elements.  The design may result in a cheap and tawdry product.  The fairness of the price is difficult to judge.  There is no architect to protect the owner from defective construction.

Building without a Permit
To bootleg construction work is risky.  When the building official discovers that work has been done without a permit, it may require that the work, or most of it, be disassembled and reconstructed with appropriate inspection.  The owner must pay a fine plus permit and inspection fees.  Worse, the owner must disclose to any prospective purchaser of the property that work was performed without a permit.  Absent disclosure, when the purchaser becomes aware of the unpermitted work, the seller will be liable for damages or perhaps be required to take the property back and refund the purchase price -- with interest.

Dealing With an Unlicensed Contractor
A project owner does have one big advantage when dealing with an unlicensed contractor: the owner can cancel the contract at any time and is not legally responsible to pay the contractor for work that has been performed.  Under the doctrine of illegality, a court would not enforce a contract to pay for a shipment of marijuana.  The court treats unlicensed contractors exactly as they would marijuana shippers.  Their contracts will not be enforced.

But there are disadvantages to dealing with an unlicensed contractor:
• An unlicensed contractor may be incompetent.
• An unlicensed contractor may be uninsured. 
• An owner who employs an unlicensed contractor, in most states, becomes liable personally to pay workers compensation benefits to any worker who might be injured on the project. 

By dealing with unlicensed Happy Tenant, Allen exposes himself to considerable risk.

The Design/Build Contract
One of the risks of utilizing the design/build method of construction is that the design may not include all the elements that it should.  Allen’s contract omitted carpeting and electrical fixtures.  So the $37,985 contract price turned out not to be such a bargain after all.

The Listing Contract
Allen listed space with Barracuda Brokers for ninety days.  Disgusted with their apparent inability to find a tenant, Allen negotiated his own lease.  Unfortunately for Allen, the listing had not expired.  Therefore, as is typical under such contracts, Allen owes a commission.  The law assumes Barracuda Realty could have found a tenant within the period of the listing if Allen had not violated the contract by negotiating a lease himself and then failing to pay the commission.

This story is an excerpt from the book, Construction Nightmares – Jobs from Hell and How to Avoid Them - which humorously narrates actual jobs gone bad from the world of construction. It deals with faults in plans, extras, delays, interference, scheduling, extra work, change orders, defective construction, inadequate supervision, and incompetent construction – just about every problem in the construction industry. Construction Nightmares can be found at http://www.bnibooks.com

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