The Work Letter-The Construction
Contract Hidden in the Lease

Part 1: 

In many commercial leases, the work letter receives far less attention than the business terms of the lease itself, even though it may ultimately become the source of the largest disputes in the transaction. That is particularly surprising given that a substantial portion of the capital invested by both landlord and tenant is often spent upfront on designing, constructing, and improving the premises. The landlord may be contributing a significant tenant improvement allowance, upgrading building systems, or performing substantial base building work, while the tenant may be investing heavily in specialized improvements, equipment, technology infrastructure, furniture, fixtures, and relocation costs. 



Despite that reality, the work letter is still frequently treated as a secondary exhibit attached near the back of the lease instead of being recognized as a miniature construction contract embedded within the lease itself.



Why Work Letters Create Major Disputes

Everybody is cooperative when the lease is signed and construction has not yet started. Then the plans are delayed, permits take longer than expected, contractors blame each other, costs increase, and the tenant changes the layout. The landlord says the allowance has been exhausted, the tenant says the premises are not ready, and the landlord says rent has already commenced. Suddenly, the work letter that everybody rushed through becomes the most important part of the lease.



These disputes can become extremely expensive. A retail tenant may miss the holiday season because construction was delayed. An office tenant may end up paying substantial holdover rent at its prior location because the new premises are not ready on time. An industrial tenant may have equipment arriving before electrical systems or utility upgrades have been completed. Landlords face major risks as well because delayed completion may postpone rent commencement, interfere with lender requirements, disrupt leasing plans for the remainder of the project, or expose the landlord to claims for damages or lease termination. 



Many disputes arise not because the parties failed to address construction issues, but because they assumed somebody else would handle them later.



The Risks of Undefined Construction Responsibilities

One of the biggest mistakes parties make is signing the lease before anyone has clearly established who is responsible for preparing plans, obtaining permits, approving revisions, coordinating contractors, or paying for changes. The parties often avoid spending money on architects and engineers until after the lease is signed. That sounds efficient in theory, but in practice it frequently creates immediate delays because nobody has committed to a realistic design schedule.



Another common problem is vague approval language. If the lease simply says that plans are subject to landlord approval, disputes can quickly arise once costs increase or timing becomes critical. A tenant may believe the landlord is withholding approval for business reasons, while the landlord may believe the plans exceed the scope of the original deal. The more objective the approval standards are, the lower the likelihood of future conflict.



A common example involves building systems. The tenant assumes the existing HVAC or electrical capacity will support the intended operations, while the landlord assumes the existing systems are already sufficient. Neither issue is fully analyzed before the lease is signed because everybody is focused on completing the transaction. Months later, after plans are finalized and contractors are engaged, the parties discover that major upgrades are required, costs increase substantially, and the construction schedule immediately begins slipping.



When Construction Starts Changing the Deal

Work letter disputes also frequently arise after construction has already started. The tenant refines the layout, the architect revises the plans, the city requires additional work, or a contractor discovers conditions behind the walls that nobody anticipated. Those changes can trigger permit revisions, construction delays, cost overruns, and disputes regarding who is responsible for the additional expense.



Many leases also fail to adequately address contractor selection. Landlords often want contractors who are familiar with the building and its systems. Tenants, however, may worry that landlord-affiliated contractors will be more expensive or less responsive.



The problem becomes even worse when construction bids exceed the tenant improvement allowance. At that point, everybody starts recalculating the economics of the deal. The tenant may expect the landlord to absorb part of the increase, while the landlord may insist the tenant cover every dollar above the allowance. The tenant may want to redesign the project, and the landlord may resist changes that create further delay.



Construction Scope and Hidden Costs

Another frequent source of conflict is the actual scope of the work. Many disputes arise because the parties never clearly addressed responsibility for core infrastructure and compliance issues before construction began. Questions involving HVAC capacity, utility upgrades, fire sprinkler modifications, ADA compliance, structural reinforcement, or roof penetrations often become major disputes only after contractors are already onsite and costs have escalated.



Timing creates another major problem. Construction schedules in leases are frequently unrealistic because they fail to account for permit delays, utility coordination, long-lead materials, labor shortages, inspections, or governmental review. The lease may contain aggressive target dates without meaningful procedures for extending deadlines or allocating responsibility for delays. Everybody assumes the project will proceed smoothly until it does not.



The Work Letter Is Really a Construction Contract

The work letter may not appear to be significant because usually it is an exhibit at the end of the lease. But it is financially significant since the work letter determines who designs, who approves, who builds, who pays, and who bears the risk when something goes wrong. The parties who treat the work letter as a secondary exhibit often discover too late that it governs the most expensive and operationally sensitive part of the lease.

Watch for Next Month’s Part II
In this 3 part series Part II turns to one of the most misunderstood provisions in the entire lease: the tenant improvement allowance, and why the number the tenant negotiated is frequently not the number available to build.