Get Right to Pass Through Costs of ‘Cost-Saving’ Capital Improvements

Although it's unlikely that your tenants will agree to let you pass through the cost of all capital improvements made at your building or center, many will agree to let you pass through the costs of capital improvements that save money (also known as “cost-saving” capital improvements). One example would be a lighting retrofit program that can result in big savings on electricity bills.

But if the language you add to your lease to give you the right to pass through the cost-saving capital improvements to a tenant is like a lot of the lease language we've seen, it may be drafted too narrowly. The result: The tenant may be able to avoid paying for certain cost-saving capital improvements. You could be left to foot huge bills for those improvements on your own.

To protect yourself from these expenditures, CLLI, with the assistance of New Jersey attorney Marc L. Ripp, will give you five drafting tips to follow. They can help you get the right to pass through all cost-saving capital improvements.

Five Drafting Tips

You should add cost-saving capital improvements to the lease's list of items included in operating expenses or CAM costs, advises Ripp. The tenant should be responsible for paying its share of the amount of an improvement's cost that's amortized each year based on the life of the improvement. Here are five drafting tips:

Have pass-through right apply to improvements “intended” to save costs. Say in the lease that the pass-through right applies to capital improvements that are “intended” to save costs, says Ripp. That is, they're intended to cause a reduction in any item of operating expenses or CAM costs or improve the utility, efficiency, or capacity of any of the center's or building's systems (such as the HVAC system), he explains. This way, if the capital improvement ultimately turns out to be less of a money saver than you intended, you can still pass through its cost.

Practical Pointer: Some tenants will accept that pass-through language, but others won't, notes Ripp. A savvy tenant may demand that you cap the pass-through at the actual amount of the cost savings, he says. It may argue that it shouldn't have to pay for a capital improvement that turns out to be a bad investment and doesn't save any money. Try not to give into that demand, suggests Ripp.

Don't limit pass-through to future improvements. Try not to limit your pass-through right to cost-saving capital improvements made after the lease is signed, says Ripp. You may have made, or started making, cost-saving capital improve-ments before the lease was signed. If the tenant is benefiting from those improvements, it should pay for them, he says.

Don't set minimum amount of cost savings. Don't set a minimum amount of money a capital improvement must save for it to qualify as a cost-saving capital improvement, says Ripp. And try not to give in to a tenant's demand that you limit the pass-through to only those capital improvements that annually save an amount that's more than the amortized cost of that capital improvement that year, he adds. Otherwise, you'll limit the pool of potential cost-saving capital improvements too much.

Get right to charge interest. In addition to having the tenant pay its share of the amortized cost of the cost-saving capital improvement, get the right to charge interest on the unamortized portion of the cost-saving capital improvement, says Ripp.

Practical Pointer: If a tenant demands that you specify the interest rate in the lease, say it will be the same as the rate you're paying on the funds you borrowed to finance that cost-saving capital improvement, says Ripp. Or, if you didn't borrow funds, say in the lease that it will be the rate that you would have paid to borrow the funds, as you determine, he adds.

Say when payments are due. Say that the tenant must pay its share of the costs of a capital improvement amortized each year beginning in the calendar year in which the capital improvement is started and in each subsequent calendar year of the lease, says Ripp. This way, you can avoid arguments about when those payments are due.

Practical Pointer: A savvy tenant may also demand that you agree to give it proof of the money saved by a capital improvement before it will pay its share of the improvement's cost. Try not to give in to this demand, says Ripp. And consider telling the tenant that, since it has a right to audit the owner's books and records, it can check for proof of money savings when it audits, he adds.

Add Lease Language

To get paid for all cost-saving capital improvements, add the following language to your lease where it lists the items included in operating expenses or CAM costs, advises Ripp. (You'll need to define “Shopping Center System” or “Office Building System,” whichever is used, elsewhere in the lease.) CLLI0051

Model Lease Language

(x) The cost of any capital improvements to the [Shopping Center/Office Building] which are intended to cause a reduction in any item of [CAM Costs/Operating Expenses] or improve the utility, efficiency, or capacity of any [Shopping Center/Office Building] System, amortized on a straight-line basis over the useful life of such improvement (as determined by Landlord). Tenant shall pay its Proportionate Share of the amortized cost of each capital improvement, plus interest on the unamortized cost of each capital improvement, during the calendar year of the Lease in which each capital improvement is commenced and in each subsequent calendar year of the Lease.

CLLI Source

Marc L. Ripp, Esq.: Counsel, The Gale Co., LLC, 100 Campus Dr., Ste. 200, Florham Park, NJ 07932; (973) 301-9500; mripp@thegalecompany.com.