Daily Development for Monday, April 7, 2003
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
dirt@umkc.edu

LANDLORD/TENANT; LANDLORD'S REMEDIES; DAMAGES;
PENALTIES: Lease provision that doubles the amount of rent in the
event of any breach is void as a penalty.

Harbor Island Holdings v. Kim, (Cal. App. 4/2/03)

The introduction by the appeals court is admirably succinct, and can be
quoted verbatim:

     "A landlord, displeased with its tenant, reluctantly agreed to a
     lease extension requiring greatly increased rental payments.  The
     landlord demanded one price if the tenant complied with the lease
     agreement in every regard and double that amount in the event of
     any breach.  After the conclusion of the extended lease term, the
     landlord sued the tenant, seeking both damages occasioned by the
     tenant's failure to properly maintain the premises, plus nearly a
     quarter of a million dollars for the doubled rent.  The trial court
     awarded damages for the failure to maintain the property, but
     held the lease provision for the doubled rent was unenforceable as
     a penalty.  The landlord appeals.  We agree with the trial court's
     reasoning and affirm."

In fact, as the court later explains, the lease phrased things in a slightly
more subtle way.  The rent, which had been around $31,000 per month
during an earlier three year term, was raised to $96,000 per month during
the three month extension (while tenant completed construction on a new
facility), but half the rent was "deferred" and ultimately would be
forgiven if the tenant performed all the covenants of the lease. In fact,
tenant posted a security deposit in the amount of the one month of the
deferred rent - or $48,000.  The landlord refused to return the deposit and
sued for the doubled rent for the entire term - around $24,000.    The trial
court found that the tenant's failure to maintain the premises caused
damages of around $14,000 and ordered the balance of the $48,000
security deposit refunded.

Apparently the landlord argued that the arrangement concerning the
$48,000 "deferred rent" was a "rental inducement."  The court here
concluded, with the trial court, that it could only be analyzed under the
California statute dealing with liquidated damages clauses.  Under that
statute, the liquidated amount must be "reasonable."  California courts
have concluded that the such a clause is "unreasonable" if "it bears no
reasonable relationship to the range of actual damages that the parties
could have anticipated would flow from the breach."

Landlord argued that the $96,000 per month was actually the rent that the
landlord was willing to accept for the property, and that tenant was
willing to pay, if the tenant insisted on being able to breach the
conditions of the lease.  The court responded that such reasoning would
permit parties always to avoid construction of lease terms as creating
penalties simply through rephrasing them as alternative forms of
performance.

The court acknowledged that both players in this little drama were
sophisticated commercial parties who knew and intended what they were
doing, but concluded that the state's policy against permitting contract
clauses creating penalties applies even in that context.  It acknowledged
that the landlord claimed that the method used here to "incentivize" the
tenant's performance was a commonly used device, but said that the fact
that it was in common use also would not change the application of the
court's ruling here.

Comment 1: Compare this case to Benderson-Wainberg, L.P. v. Atlantic
Toys, 228 F. Supp. 2d 584 (E.D. Penn. 9/17/02) Shopping center landlord
may enforce contract provision giving it an amount equal to the base rent
for everymonth a defaulting tenant's premises remains vacant and in
addition can charge a 2% per month late fee on the amounts of actual
rent owed for
that period.) (New Jersey law), the DIRT DD for 2/18/03.

Comment 2: The case likely is more consistent with prevailing law than
the Benderson-Wainberg ruling.  Even sophisticated parties cannot
bargain to create penalties.

Readers are encouraged to respond to or criticize this posting.

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