Daily Development for Monday, July 7, 2008
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

The reporter for this item was Dale Whitman, of the Missouri-Columbia Law School (emeritus)

LANDLORD TENANT; COMMERCIAL; SHOPPING CENTERS; EXCLUSIVE USE CLAUSE; LIQUIDATED DAMAGES:   Court upholds a clause requiring payment of $100,000 for breach of a restriction on  competition in a shopping center lease despite no provable loss. .

Valentine's, Inc. v. Ngo, 251 S.W.3d 352 (Mo.App. Southern Dist.2008).

Valentine’s leased about 4,000 square feet of space in a shopping center to operate a full-menu restaurant. The lease was for 15 years, with an initial rent of $4,600 per month. Because Valentine’s did not want other space in the center to be leased to a competitor, it insisted that the following clause be included in the lease.

Landlord agrees to not lease any space in the retail building to any other restaurant which serves steaks, seafood or pasta. In the event Landlord violates this non-competition clause it agrees to pay Tenant the sum of $100,000.00 as and for liquidated damages, it being acknowledged, that damages in the event of such a breach would be difficult, if not impossible to ascertain.

Subsequently, the Ngos, owners of the shopping center, leased another space to the Baja Grill, a Mexican restaurant. The evidence was clear that Baja Grill sold steak and seafood dishes, thus causing a violation of the non-competition clause. The trial court ordered an award to Valentine’s of $100,000, and the Ngos appealed.

The appellate court noted that Missouri follows the Restatement (Second) of Contracts §356, which provides that:

Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of anticipated or actual loss caused by the breach and the difficulties of proof of loss. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy.

The Restatement is ambiguous in the sense that either “anticipated” or “actual” loss may be the standard against which the reasonableness of the liquidated sum is measured. However, the Missouri court took the view, as have most cases in recent years, that the test is ex ante: is the liquidated sum a reasonable advance estimate of the probably damages?

The court noted that Valentine’s had insisted on the $100,000 liquidated sum because that was approximately the amount its contractor indicated was going to be spent on leasehold improvements before the restaurant opened. (In fact, it spent $124,000, plus an additional $140,000 in further improvements after opening.) The court conceded that “the $100,000 is not directly related to any actual loss of profits that would occur if [Landlord] breached the lease agreement by leasing space to another restaurant that sold steak, seafood, and pasta.” But it nonetheless upheld the liquidated sum, noting that lost profits are notoriously difficult to measure. The harder it is to measure, the less weight should be given to the reasonableness of the estimate, the court said.

The court also assessed the clause’s reasonableness by comparing the amount to the total sum Valentine’s would spend on rent on the restaurant: about $890,000 over the 15-year term of the lease. The liquidated sum was 11.2% of this total, and prior Missouri cases had upheld liquidated damage clauses for far greater percentages of the contract’s total value.

Reporter’s Comment 1: The court was exceedingly kind to the plaintiff tenant in this case. The tenant never produced any evidence whatever that its sales or profits had declined as a result of the advent of the Baja Grill into the shopping center. Yet Missouri has always applied the doctrine that no liquidated damages can be recovered unless there is proof of at least some actual damages. For all we or the court know, the Baja Grill may have generated more traffic in the shopping center, resulting in an actual increase in sales and profits to Valentine’s.

Reporter’s Comment 2: Aren’t the measures the court applies completely irrelevant? What do the damages resulting from a competing restaurant have to do with the amount the tenant expected to spend on leasehold improvements, or on rent for the 15-year term? These comparisons are completely arbitrary, since they have no bearing and shed no light on the restaurant’s profitability or the effect of the Baja Grill on it.

Reporter’s Comment 3: Yet, when all is said and done, is $100,000 a reasonable advance estimate of what it might cost a restaurant if a competing restaurant moved in nearby? Probably so. And while liquidated damage clauses are not supposed to be punitive, or to punish the breaching party, they ought to impose enough of a bite to discourage breaches. On this basis, $100,000 seems about right.

Editor’s Comment 1: The editor favors a “hardball” approach here, which means the editor would uphold the deal unless it is patently unreasonable, which, as Dale agrees, it is not.  This is a commercial lease between consenting parties with regard to an injury as to which damages would be difficult to ascertain.  Under those circumstances, great latitude should be given to the parties’ stipulation of damages.  For another case of similar import, see: Bates Adver. USA, Inc. v. 498 Seventh, LLC, 850 N.E.2d 1137 (N.Y. 2006) (A lease provision entitling a tenant to rent abatement if the landlord fails to complete safety and security improvements as specified is a permissible liquidated damages provision and not a penalty unless the challenging party shows that tenant's actual damages were readily ascertainable at the time of contract or that the provision entitles tenant to a benefit grossly disproportionate to its actual damages. )

Editor’s Comment 2: A frequently overlooked problem here is the fact that, unless the exclusive use lease is recorded, other possible future tenants may take with no knowledge of it, and therefore are not bound by it.  Thus, the tenant indeed will suffer the injury over the life of the competing lease.  This makes the case for liquidated damages stronger.  See, e.g. Mabros v. DonutsRUs, Inc., 536 S.E.2d 215 (Ga. App. 2000) (dicta) (Where a landlord transfers property subject to a radius clause to a transferee who has no knowledge of the clause, the transferee may take as a bona fide purchaser free of the restrictions, but the landlord may remain liable in damages to the party protected by the clause if such party can show that there has been diminution in the value of the premises as a result of the violation.)  Of course, the protected tenant may also want to get the exclusive use right into the record so as to support injunctive relief.  Tenants should watch out for the fact tha

t the shopping center may consist of several parcels, and recordings should be made against each.  These issues are discussed in Friedman on Leases (Randolph edition) at Section 28:6.1 and in note 69 and accompanying text of the same Chapter 28.

The new tenant arguably may be on inquiry notice of the rights of each tenant in a shopping center.  But is this an appropriate burden to place on such a tenant? 

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