Biotech Lab Leases: Facility Build-Out Issues For Landlords & TenantsBy James Blake on
Selecting a laboratory facility, customizing it with building improvements, and getting all of the necessary regulatory approvals for the site (FDA, CDC & DHHS) can be one of the most expensive and time consuming hurdles for a biotech company, sometimes taking four or five years. Commercial landlords who lease space to a biotech company also face a major challenge: the time required for build-outs and regulatory approval combined with the volatile nature of the biotech industry results in a very high amount of risk tied to their lease. Because the build-out and approval processes are so expensive, time consuming, and risky, landlords and biotech tenants alike must fully understand the nature of the endeavor, strive to cooperate together, and reach very clear provisions for all aspects of the lease. Here are some considerations for the build-out provisions of a biotech laboratory lease.
The High Cost of Property Improvements – Who Pays?
Improvements to prepare a location for use as a biotech facility are typically 5 to 10 times more expensive than ordinary commercial leases, as they often require special features such as static-reducing floors, specialized HVAC systems, and lots of electrical outlets. Additionally, if the facility is an old structure, FDA approval may be impossible to achieve without significant renovations to drainage systems, airflow systems, etc.
Landlords typically try to push the bulk of renovation costs on their tenants. However, in all fairness, the landlord should be responsible for improvements that relate to the building generally, such as HVAC, electrical systems, and drainage systems. Specialized improvements that are specific to the biotech company’s operations, such as subterranean storage tanks, static-reducing floors, backup power generators, etc., will need approval from the landlord, and the tenant should be responsible for those costs. Generally, the landlord will want to reduce specialized tenant improvements to the greatest extent possible because these improvements often cause greater renovation expenses for subsequent leases. The build-out provisions should include specific terms governing the approval processes for tenant improvement plans and should give the tenant flexibility to make additional improvements in the future as the company’s operations and uses of the facility may expand or change.
Financing the Build-Out
Landlords must try to limit the financial risks that attend the long period of time between signing the lease, completion of the build-out, and the contingency of regulatory approvals. Thus, in addition to a full investigation of the tenant’s financial health, lease provisions for periodic audits of the company’s financials, and a large security deposit, the landlord needs other provisions to give them security in the build-out process.
Landlords may require the tenant to deposit funds into an escrow account to cover any tenant improvements that exceed the tenant improvement allowance. For the biotech company, depositing a large sum of cash into an escrow account can be detrimental to cash flow. Thus, a good alternative is to provide the landlord with a letter of credit, which typically costs between 1% and 2% of the maximum draw amount. Alternatively, the tenant can use a lease bond. These options are also advantageous to the landlord, because they give the landlord significant asset protection benefits if the tenant declares bankruptcy. In a bankruptcy proceeding, letters of credit and similar credit guarantees are third-party obligations that do not become part of the debtor’s bankruptcy estate, whereas a cash deposit in an escrow account would become part of the debtor’s bankruptcy estate, and thus, could be subject to other claims and costs incurred in bankruptcy.
Tenants may also benefit by decreasing their reliance on tenant improvement allowances to the greatest extent possible. A tenant improvement allowance is essentially a landlord-financing mechanism, and the cost is always factored into base rent. Tenants will likely be able to find financing from other sources at a much lower cost, reducing both the cost of the build-out and the recurring cost of rent.
These solutions are just a few options that commercial landlords and biotech tenants should consider for their build-out provisions. To fully protect your company’s assets, rights, and security in all types of commercial leases and real estate transactions, contact The Blake Lake Firm.