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RECENT RULING HIGHLIGHTS THE IMPORTANCE OF DAMAGES PROVISIONS IN COMMERCIAL LEASE CONTRACTS

Posted on: May 2nd, 2012 by admin No Comments

A recent Massachusetts Appeals Court ruling highlights the importance of negotiating and drafting applicable damages provisions in commercial lease contracts.  When possible, landlords must seek a well-drafted liquidated damages provision in each commercial lease agreement, providing for the landlord’s ability to accelerate rent for the balance of the lease term in the event of a tenant default.  Conversely, tenants will want to eliminate or, at the very least, “water down” such a clause as much as possible. 

In 275 Washington Street Corp. v. Hudson River Intern., LLC, 81 Mass.App.Ct. 418, 963 N.E.2d 758 (2012) (Lawyers Weekly No. 11-038-12) the Appeals Court ruled that a commercial landlord whose tenant broke a 12 year lease after only 24 months, must wait until the expiration of the entire lease term before suing for damages.

The relevant commercial lease agreement had only a basic indemnification provision, entitling the landlord to be indemnified by the tenant for any losses that occurred as a result of the tenant’s breach of the lease agreement.  Noticeably absent from the lease was a liquidated damages clause, allowing the landlord, in the event of the tenant’s breach, to accelerate the balance of the unpaid rent owed by the tenant through the end of the lease term. 

Following the tenant’s default only 2 years into the 12 year lease agreement, the landlord re-entered the property and took possession of the commercial lease space.  Shortly thereafter, the landlord filed a breach of contract suit against the tenant, seeking unpaid rent for the balance of the 12 year lease term and other damages, including for money spent by the landlord on a build out sought by the tenant.  While the landlord’s breach of contract lawsuit against the former tenant was pending, the landlord entered into a 10 year lease agreement with a separate, replacement tenant for the same leased space.  The new lease term with the replacement tenant went beyond the original 12 year term, but was for less monthly rent.

Traditionally, the law has been that pursuant to a standard indemnification provision, a commercial landlord must wait until the end of the lease term to file suit to recover its damages.  The rationale for this law, is that an indemnification provision limits a landlord to recovery for those damages actually incurred.  Accordingly, if a lease term has not yet expired, the landlord’s damages technically remain unknown until the lease term expires. 

Originally, in 275 Washington Street Corp., the Superior Court awarded the landlord summary judgment, holding that because a replacement tenant was found, the landlord’s full damages were now known because the premises was currently rented.  The trial judge ruled that the landlord was entitled to immediately recover the difference between all unpaid rent through the balance of the 12 year lease term due to the original tenant’s default, less the rent the landlord expected from the replacement tenant. 

Unfortunately for the landlord, the Appeals Court overturned the Superior Court’s ruling, holding that because the indemnification agreement limited the landlord to reimbursement for losses actually incurred as a result of the tenant’s breach, and the full scope of the tenant’s breach could not be ascertained until the end of the lease term (notwithstanding the lease with the replacement tenant).  The court concluded that the landlord had to wait until the expiration of the lease term before calculating what its actual damages would be.  The landlord argued unsuccessfully, that because it secured a replacement tenant, its damages were fully ascertainable and it did not have to wait until the end of the 12 lease term.  The Appeals Court disagreed, finding that even though a replacement tenant was found, that replacement tenant could also default, thus making the landlord’s damages once again unknown until the end of the full lease term. 

Importantly, the Appeals Court noted that if the landlord’s commercial lease contract contained a liquidated damages provision, providing for the landlord’s ability to accelerate rent for the balance of the lease term in the event of the tenant’s default, the landlord would be able to secure damages through the end of the lease term by filing suit immediately.

Obviously, this ruling highlights the importance of proper language in a commercial lease contract.  Landlords will want to include a comprehensive liquidated damages provision, allowing them to accelerate rent through the balance of the lease term in the event of a tenant’s default.  Tenants will try to eliminate such lease provisions, or at least attempt to minimize the exposure they may incur.  There are several creative ways that tenants can attempt to negotiate such provisions.  However, ultimately, the ability to negotiate a commercial lease contract typically depends upon the commercial lease market (higher vacancy rates is often equated with flexible landlords), the personality and relative aggressiveness of the landlord and the amount of space and length of the tenant’s lease term (the larger the space and longer the lease term, the more bargaining power a tenant might have).

Bennett & Belfort, P.C. will strive to continue to update you on the varied developments in this rapidly evolving area of real estate litigation which significantly impacts commercial lease drafting and lease negotiations.

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