LANDLORDS MUST CAREFULLY IDENTIFY DAMAGE PROVISIONS IN COMMERCIAL LEASES

Published on: May 17, 2013

Recently, the Massachusetts Supreme Judicial Court (“SJC”) had an occasion to review the case law and policies concerning the interpretation of damage provisions in commercial leases in the event of a default.  To that end, in the matter of 275 Washington Street Corp. v. Hudson River International, LLC, SJC 11217 (April 30, 2013), the SJC considered a case involving a commercial landlord who entered into a twelve (12) year commercial lease with a tenant who was to use certain premises as a dental office, and to pay the landlord monthly rent plus a share of the operating costs and real estate taxes.  The lease provided that in the event of a default, the landlord had the right to reenter the premises and to declare the term of the lease ended “without prejudice to any remedies which might be otherwise used for arrears of rent of the default.”  The lease further included an indemnification clause which provided that “Tenant shall indemnify Landlord against all loss of rent and other payments which Landlord may incur by reason of such termination during the remainder of the term.”  The lease did not grant the landlord a liquidated damages remedy or any other remedy aside from the indemnification provision. However, the lease did provide for cumulative remedies.

The tenant took possession on April 16, 2006, but closed its dental office in May 2007 and removed all of its equipment in October 2007. The tenant made base rental payments through March 2008, but then it subsequently stopped making payments. On May 7, 2008, the tenant notified the landlord that it would not be making any further rental payments and on May 19, 2008, the landlord re-entered and took possession of the premises, thereby terminating the lease. Thereafter, the landlord entered into a new ten (10) year lease with a new tenant, with a lease term that extended beyond the original termination date of April 16, 2018 under the terms of the original lease, but at a lower base rent than was agreed to by the original tenant.

On May 29, 2008, the landlord filed suit in the Superior Court against the tenant and the guarantor under the lease for breach of contract to recover damages under the terms of the original lease. Through the Superior Court action, the tenant conceded that it was liable for unpaid rent that became due prior to the termination of the lease, but the tenant argued that the landlord could not recover under the indemnification provision of the lease, until the term of the original lease ended.  The Superior Court ultimately found that the landlord was entitled to pre-termination damages in the amount of $37,176.24, lost rent from the termination of the lease to September 2010, when the new tenant took occupancy of the premises in the amount of $449,759.92, and attorneys’ fees in the amount of $103,367.91, for which the tenant and guarantor were jointly liable.

In reviewing the case on appeal, the SJC cited to the well settled law in this Commonwealth that when a landlord terminates a lease upon the default of a tenant, the tenant is obligated to pay the rent due prior to the termination but the tenant does not have any obligation to pay rent that may accrue after the date of termination, unless the lease provides otherwise. For this reason, most commercial leases provide express provisions which clearly set out a landlord’s remedies in the event of a breach. Such provisions may take the form of a liquidated damages provision which contractually obligates a tenant to make a specified payment or series of payments in the event of default. An indemnification provision does not provided for a liquidation of damages, but rather requires a defaulting tenant to reimburse the landlord for the actual losses that the landlord suffers as a result of the breach of the lease.  However, unlike a liquidated damages provision wherein the damages are readily ascertainable, under an indemnification clause, the actual damages cannot usually be determined until after the end of the period set out in the lease. This rule is true even if the property is re-let before the end of the original lease term because commercial leases are not always limited to base rent only and there is always the uncertainty that the subsequent tenant may also default under their lease. Accordingly, it is nearly impossible to determine with a reasonable degree of certainty what a landlord’s damages are under an indemnification provision in a commercial lease until the term of the original lease expires.

To that end, the SJC held that “[i]f the landlord wants the indemnified amount to become due once the property is relet, it may insist that the lease so provided, and identify the means to calculate the amount of the indemnified loss.  Where the consequence of contractual silence has been clear under our common law, and where landlords need not enter into any lease that fails to provide them with the remedies they desire for posttermination loss, we see no justification to change our common law to give landlords an earlier due date for indemnification than that which they negotiated.”

Ultimately, the SJC upheld the Superior Court’s award of pre-termination damages, and further held that if there is a cumulative remedy provision contained within the lease, the landlord may seek any alternative remedy for post-termination damages and that it is not limited to pursuing indemnification simply because of the provision in the lease allowing for the same. Moreover, the SJC held that where the lease has been executed by a guarantor, the liability of such guarantor cannot exceed the liability of the tenant. Thus, if the landlord is precluded from recovering post-termination damages from a tenant under the terms of an indemnification provision in the lease until the expiration of the original lease term, it is similarly prevented from seeking the same from the guarantor until the expiration of the original lease term.

In short, landlords have an opportunity at the outset of any commercial lease to negotiate at length the terms of the lease agreement and should include any and all remedies in the lease agreement so as not to be delayed in their recovery of damages in the event of a default, and/or so as not to be otherwise prevented from recovering the full breadth of their damages.

In this regard, attorneys drafting commercial lease agreements should carefully discuss the terms of the lease with their clients to avoid potential ambiguity and future litigation.  Default provisions and potential remedies should be specific so that both the landlord and the tenant understand their respective rights, duties and obligations under the lease before signing.

In the matter of 275 Washington Street Corp. v.  Hudson River International, LLC , had the landlord incorporated a liquidated damages provision to the lease providing a specific remedy, or specified in the indemnification provision that damages could be recovered earlier than the period specified in the lease in the event of default by the tenant, then the landlord would have had an immediate remedy as opposed to having to delay his recovery until the end of the lease term called for under the terms of the original lease.  For example, the landlord could have included a specific date or dates prior to the lease term when the landlord’s indemnification clause would be triggered, and by what events, to measure the landlord’s damages at a time certain.  In conjunction with such a clause, the landlord would have been well-advised to include a liquidated damages provision specifying damages payable to the landlord in the event of tenant’s default.  These types of liquidation provisions can range from requiring the tenant to pay the monthly rental amount under the terms of the lease despite the termination, to full acceleration of the full amounts owed for the full duration of the lease.  Massachusetts courts are inclined to uphold liquidated damage provisions in leases entered into between sophisticated parties.

The lesson for attorneys drafting commercial lease agreements is to carefully consider each provision, particularly default provisions and potential remedies to avoid protracted and uncertain litigation.  The prospect of a tenant defaulting under the terms of a lease is always a foreseeable possibility and therefore, the landlord should always include specific remedies within the lease to protect itself in the event of default by the tenant.