Landlords and their lenders need to rethink their position on payment of construction allowances. The rental structure of a lease is based in part on the amount of the allowance. If a tenant receives no allowance, the lease would undoubtedly provide for a lower rent payment. A portion of the rent is repayment of the allowance with interest. Yet, I see landlords and lenders insist upon provisions that ignore the reality of the allowance structure.
1. Landlords often insist that the allowance only be used for certain items and that the tenant provide evidence that it is spending the allowance only on these items. And that the tenant will not receive the allowance to the extent it does not so spend the funds. However the landlord is unwilling to reduce the rent if tenant does not get the full allowance. The landlord thus gets a windfall: tenant pays the full rent including that portion allocable to the allowance, but does not get the full allowance. The essence of the lease is defeated. It would seem, that either the landlord should agree to pay the allowance, regardless of costs, or should agree to a rent reduction to the extent the full allowance is not paid. Landlords sometimes say this is a requirement of their lender. If that is really the case, the lender needs to rethink their position based on the reality of the structure of the lease.
2. Lenders are increasingly refusing to allow a tenant to offset rent for any part of the allowance not paid (as it relates to a post foreclosure offset). Once again, this leads to the tenant paying full rent (for which the lender or its assignee gets the full benefit) without receiving the full allowance. If the lender approves the lease, and in fact the execution of the lease benefits the lender as it increases the value of its security, the lender should allow the offset separate and apart from the fact that it gets the benefit of the full rent.
3. Landlords sometimes insist that upon default, in addition to the other damages, landlord wants repayment of the unamortized allowance. However, the tenant is obligated to pay the rent – unpaid rent is clearly an element of damages. If the rent includes repayment of the allowance, having the unamortized allowance included as a separate element of damages is a double recovery for landlord.
Resolving this issue not only solves difficult lease issues, but would alleviate a key issue in the SNDA.