Reimburse Tenant for Unamortized Capital Improvements Required Near Lease End

September 30, 2004

Issue to Negotiate

You're negotiating with a tenant who'll be responsible for making and paying for all capital repairs, improvements, and replacements in its space. Should the tenant still be responsible for making and paying for capital repairs, improvements, or replacements if their useful life will extend beyond the remainder of the lease term?

Issue to Negotiate

You're negotiating with a tenant who'll be responsible for making and paying for all capital repairs, improvements, and replacements in its space. Should the tenant still be responsible for making and paying for capital repairs, improvements, or replacements if their useful life will extend beyond the remainder of the lease term?

Owner's View

The tenant's obligation to repair, improve, and replace should apply to all capital repairs, improvements, or replacements during the lease term—including those that have a useful life extending well beyond the remainder of the lease term. After all, the tenant will very likely get some benefit from them before the lease ends.

Tenant's View

The tenant will argue that it's not fair to require it to pay for a capital repair, improvement, or replacement whose useful life extends beyond the term of its lease. The tenant may not be in the space long enough to benefit from it. Rather, you and your future tenants may benefit from it far more than the tenant.

Compromise: Fairly Allocate Cost of Capital Expenditures

Rather than argue with the tenant over this issue, consider this compromise suggested by Los Angeles attorneys Pamela Lynne Westhoff and Samantha S. Goodman: If a capital repair, improvement, or replacement is required near the lease end, the tenant should be responsible only for the cost of that capital repair, improvement, or replacement on an amortized basis (based on the number of months left in the lease term), says Westhoff. You should have to reimburse the tenant for the unamortized portion of the cost (that's the portion that falls outside of the lease term). This way, you and the tenant fairly share the cost of the capital repair, improvement, or replacement, she notes.

Example: The tenant must spend $100,000 to replace the HVAC system one year before the end of its lease. Because the HVAC system has a useful life of 10 years, it's amortized at $10,000 each year, assuming no interest ($100,000 ÷ 10 years). When the lease ends, nine years remain on the HVAC system's useful life. You'll reimburse the tenant for the unamortized portion of the HVAC system—that is, $90,000 (9 years × $10,000).

This compromise should satisfy a tenant because the tenant won't have to pay the full cost of any capital repairs, improvements, or replacements required near lease end, says Westhoff. But the tenant will still be responsible for the cost of any capital repairs, improvements, or replacements required earlier in the lease—even if its useful life extends beyond the remainder of the lease term, notes Goodman.

Three Drafting Tips

Here are three tips to consider when drafting this compromise:

Specify capital improvements eligible for reimbursement. Specify which capital repairs, improvements, and replacements will be eligible for reimbursement. Goodman and Westhoff suggest limiting eligibility to capital repairs, improvements, and replacements you require in the two years before the lease expires or terminates. But expect a tenant to request that eligibility start sooner than that.

Reimburse “reasonable” costs. Agree to reimburse only the unamortized portion of the “reasonable” expenses that the tenant incurs for the capital repair, improvement, or replacement, say Goodman and Westhoff. It's important to reimburse only reasonable expenses, says Westhoff. Otherwise, a spiteful tenant may make an unnecessarily costly capital improvement and pass on the unamortized portion of that unreasonable expense to you, she warns.

Say how unamortized portion will be calculated. To avoid confusion, say in the lease that you'll determine the unamortized portion of a capital repair, improvement, or replacement based on the following:

  • The date of its installation; and

  • Its useful life (determined in accordance with generally accepted accounting principles).

Add the following language to your lease, advise Goodman and Westhoff: CLLI0042

Model Lease Language

Subject to Landlord's repair and maintenance obligations expressly set forth in this Lease, Tenant agrees to [insert list of tenant's maintenance, repair, and replacement obligations]; provided, however, that if any capital repair, improvement, or replacement is required during the last [insert #, e.g., 2] years of the Lease Term, then, upon the expiration or earlier termination of this Lease, Landlord shall reimburse Tenant for the unamortized portion of the reasonable expenses incurred by Tenant in connection with such capital repair, improvement, or replacement based upon:

  • (i) The date of the repair, improvement, or replacement, and

  • (ii) The useful life of the capital repair, improvement, or replacement as determined in accordance with generally accepted accounting principles.

CLLI Sources

Samantha S. Goodman, Esq.: Piper Rudnick LLP, 550 S. Hope St., Ste. 2300, Los Angeles, CA 90071; (213) 330-7723; samantha.goodman@piperrudnick.com.

Pamela Lynne Westhoff, Esq.: Partner, Piper Rudnick LLP, 550 S. Hope St., Ste. 2300, Los Angeles, CA 90071; (213) 330-7747; pam.westhoff@piperrudnick.com.

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