|May 9, 2013|
Previously published on May 2013
The Massachusetts Supreme Judicial Court’s decision in 275 Washington Street Corp., Trustee v. Hudson River International, LLC, SJC-11217 (April 30, 2013), highlights the importance of carefully negotiating and drafting the remedies provisions in commercial leases to ensure practical and effective options in the event of a tenant default. Remedies provisions are often heavily negotiated, with the final language varying widely based on the strength of the tenant’s bargaining position. Major tenants and national tenants often insist on starting discussions from their own lease forms, which generally lack specific language providing the landlord with the right to accelerate rent or obtain liquidated damages in the event of tenant default. Some landlords, including the landlord in 275 Washington Street Corp., use lease forms that contain only a general provision requiring defaulting tenants to “indemnify” the landlord from losses suffered as a result of the tenant’s lease default. The Supreme Judicial Court has now ruled that a commercial landlord must wait until the end of the lease term to seek damages under such an indemnification provision.
In April 2006, plaintiff 275 Washington Street Corp., as trustee of Washington Street Realty Trust II (landlord), leased commercial space to defendant Hudson River International, LLC (tenant) for a twelve-year term. The tenant was to use the premises for a dental practice, paying a monthly base rent along with a share of operating costs and real estate taxes. In the event of lease termination for tenant breach, the lease contained a clause that required the tenant to indemnify the 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 provided for cumulative remedies, but contained no specific language providing for rent acceleration or payment of liquidated damages to the landlord.
The tenant closed its dental practice approximately one year into the term, removed its equipment in October 2007 and stopped making rent payments in April 2008. Following written notice to the tenant, the landlord terminated the lease and took possession of the premises in May 2008. Subsequently, the landlord filed a breach-of-contract claim in Superior Court, seeking damages for unpaid rent up to the date of the complaint, immediate payment of “all of the damages” resulting from breach of the lease, and to enforce an associated guaranty. On March 26, 2010, while the case was pending, the landlord entered a new ten-year lease with a replacement tenant for a lower base rent amount. On cross motions for partial summary judgment, a Superior Court judge ruled in favor of the landlord. On appeal, the Massachusetts Appeals Court vacated the portion of the judgment assessing damages, after which the Massachusetts Supreme Judicial Court granted further appellate review.
The Supreme Judicial Court upheld the Appeals Court ruling, deciding that the landlord could not recover indemnification damages until expiration of the tenant’s twelve-year lease term because indemnification is intended to reimburse the landlord for actual losses, which cannot be ascertained with reasonable certainty in advance. The Court affirmed the continuing validity of the common law rule that “when a landlord terminates a lease following the default of a tenant, the tenant is obligated to pay the rent due prior to the termination but has no obligation to pay any rent that accrues after the termination unless the lease otherwise provides.” The Court recognized that its decision could result in the landlord being unable to recover its full damages because before the time for suit, the tenant “could be dissolved or declared bankrupt, leaving the landlord at a complete loss vis-à-vis the defaulting tenant.” Explaining its decision, the Court focused on a commercial landlord’s ability to negotiate for specific remedies in a lease, including acceleration of all or a substantial portion of future rents in the event of a default:
“A landlord left without an adequate remedy following breach of the lease by a tenant has only itself to blame for entering into a lease that fails to provide such a remedy. We shall not disrupt the settled expectations of leasing parties in order to protect a landlord from the consequences of failing to insist on an adequate remedy in the negotiation of a commercial lease. Nor shall we invite uncertainty as to the availability and scope of a landlord’s remedy for “benefit of the bargain” damages where the contours of such a remedy are not delineated in the lease but left to be determined under the common law. [Emphasis added.]”
The Court also rejected the landlord’s assertion that post-termination damages could be assessed immediately against the guarantor, ruling that “the liability of the guarantor cannot exceed the liability of the debtor.”
Landlords may wish to review the remedies available to them in the event of tenant breach under their existing commercial leases and their standard lease forms, and to determine if their standard forms should be updated to reduce the risk of being unable to recover full damages for tenant breach.
For existing leases, evaluation of landlord’s remedies for breach in light of the 275 Washington Street Corp. case may influence the landlord’s choices in the event of a tenant default (e.g., whether or when to terminate the lease). Landlords may also be interested in assessing how the 275 Washington Street Corp. case could alter the power dynamics in any ongoing or anticipated negotiations with tenants.
For future leases, landlords should consider their remedies following lease termination, including whether to negotiate for a comprehensive liquidated damages provision that requires tenants to make a specified payment or series of payments in the event of lease default. Care must be taken when using a liquidated damages clause to ensure that liquidated damages are not so disproportionate to anticipated damages that a court could rule that they are an unenforceable penalty.
Experienced counsel can assist in evaluating risk, exploring alternatives, managing tenant negotiations and drafting lease documents. Attention to remedies provisions in leases and consultation with experienced counsel will help ensure timely recovery of lost future rents.