Upon further review by the Supreme Judicial Court (SJC), the court found that a liquidated damages clause in a commercial lease that entitled a landlord to nearly five years of rent payments after a tenant’s breach of the lease was enforceable as liquidated damages even though the landlord re-rented the premises at issue.
What are liquidated damages?
If a breach of contract occurs, a liquidated damages clause entitles the party not committing the breach to collect from the party committing the breach an amount corresponding to what the parties predicted the breach would cost the party that did not commit the breach.
In the case at issue, a commercial landlord entered into a five-year lease with a tenant. The lease was personally guaranteed by the owner of the company leasing the property in which the owner guaranteed prompt payment of rent and the performance by the tenant of all financial and nonfinancial obligations arising out of the lease. The lease provided that in the event the tenant failed to pay the rent due, after a ten-day grace period and notice to the tenant, the landlord would have the right to terminate the lease and the entire balance of the rent due and owing under the lease would be payable as liquidated damages. Both the landlord and the tenant agreed that such amount was a reasonable estimate of the actual damages likely to result from such breach.
Less than one month after the lease agreement came into effect, the tenant lost a contract with one of its major clients. As a result, the tenant was unable to pay its rent. The landlord sent a notice of default and after ten days commenced an action in the District Court to take possession of the property and obtain a judgment on the amount provided in the contract. One year after the tenant had vacated the premises, the landlord secured a four-year lease with a new tenant. The landlord later filed a complaint in Superior Court to enforce the owner’s obligation as guarantor of the lease.
The Superior Court concluded that the liquidated damages clause was enforceable. Furthermore, the Superior Court found that the guarantor was “sufficiently sophisticated” to have understood that he would be liable if the tenant failed to meet its obligations. The Appeals Court reversed the decision of the Superior Court stating among other things that the liquidated damages clause failed to provide for the possibility that the landlord could relet the premises and collect rent from a new tenant in mitigation of the breach. Thus, the Appeals Court determined that the liquidated damages provision was an unenforceable penalty. The SJC disagreed.
In its ruling the SJC found that a liquidated damages provision in a contract that clearly and reasonably establishes liquidated damages should be enforced so long as it is not disproportionate to anticipated damages as to constitute a penalty. Furthermore, the SJC found that a liquidated damages clause will be enforced if: (a) the actual damages resulting from the breach were difficult to ascertain at the time the contract was signed; and (b) the sum agreed on as liquidated damages represented a “reasonable” forecast of damages expected to occur in the event of a breach. The tenant failed to present any evidence that the damages resulting from the breach were easily ascertainable at the time the contract was signed or that the liquidated damages set forth in the contract were disproportionate to a reasonable estimate of actual damages likely to result from a breach of the contract.
Implications of the SJC Ruling for Tenants and Landlords
For tenants, it is clear that the time to evaluate whether or not the amount of liquidated damages provided for in a contract are reasonable is at the time the contract is executed. When a tenant is determined to be a sophisticated party to a contract (a lease), courts are going to enforce the liquidated damages clause. Tenants will have to seek an expert opinion to show that the amount of damages claimed is excessive. Tenants should also consider negotiating a right of set off if the landlord is able to find a new tenant in the event of a breach. For landlords, the SJC’s ruling reaffirms that parties to a contract who bargain freely and set their own consequences in an event of a breach that the liquidated damages set forth in the contract will be upheld.
The litigation attorneys at Wilchins Cosentino & Novins LLP are ready, willing and able to assist with litigation matters and have a proven track record of successfully representing both landlords and tenants in lease negotiation and litigation related to commercial leases and breach of contract matters.
This article is not legal advice and should not be taken as such or relied upon as legal advice.