DIRT DEVELOPMENT for March 5, 2009
Daniel B. Bogart
Donley and Marjorie Bollinger Chair in Real Estate Law
Chapman University School of Law, Orange, California
COMMERCIAL LEASES; RENT ACCELERATION AND DAMAGES: Landlord entitled to damages as a result of tenant’s breach of commercial office lease and resulting default judgment, but is denied acceleration of rents where landlord accepted tenant’s surrender.
16 Cobalt LLC v. Harrison Career Institute, 2008 WL 5135633 (D.D.C. December 8, 2008)
On December 9, 2003, K Associates, the predecessor to the landlord’s interest in the lease, entered into a ten year office lease with Harrison Career Center (the tenant) for one and a half floors of space in a building located on K Street in Washington, D.C. The tenant ceased paying rent in June of 2005. Landlord and tenant signed an agreement in which landlord agreed to accept tenant’s surrender of the space on January 6, 2005. The tenant physically vacated the space four days later. According to the landlord’s complaint, the tenant failed to pay any of the “Rent due and owing” after the tenant quit the space.
Not surprisingly, the landlord filed suit against the tenant to collect damages resulting from tenant’s breach of the lease. The tenant did not file a response to the initial complaint, and the landlord proceeded to request a default judgment. Initially, the landlord demanded $3,381,801.22 in damages. However, the court requested supplemental information, and the landlord’s revised motion requested instead $1,972,247.62, and was accompanied by an itemized list of damages. The court explained that this amount reflected “(a) the total value of the lease (i.e. past rent due and future rent that would have been paid through the term of the lease ending in 2014), late charges, attorney’s fees and costs, as well as leasing commission fees and tenant improvement costs incurred in reletting the premises, minus (b) the security deposit paid by [the tenant] and the rental payments (both past and future) due from three new tenants to whom [the landlord] had relet portions of the Leased Pre
mises.”
The court entered a default judgment of $1,972,247.62. This caught the tenant’s attention, and it filed a motion to set aside the default judgment. The court denied the tenant’s motion, stating simply that the tenant could not demonstrate excusable neglect or meritorious defense to liability. This meant that the tenant remained liable in damages to landlord, including liability for “past and future rent through the end date of the lease.”
However, the court also explained that it was unable to determine the amount and timing of payments of damages due to the landlord, and chastised the parties for their “extremely sparse and cursory briefing” of the issues.
The court focused on two issues: “(a) whether the amount of damages must be reduced to reflect [the landlord’s] reasonable efforts to relet the Leased Premises and any rents thus obtained, and, if so, by how much; and (b) whether the damages, as related to future rents owed, could be legally paid in a single lump sum now or rather must be paid in periodic installments as such rents become due.” Because of these two outstanding issues, the court requested additional briefing. The December 8, 2008 opinion which is the subject of this Development case summary results from the court’s consideration of the parties’ responses to this request.
In its December 8 opinion, the court provided some but not complete finality. This is because the parties’ failure to explain the law to the satisfaction of the court continued in this second round of argument. The court did permit the landlord to recover damages, although not in the entirety demanded by the landlord. The landlord sought remedies under two provisions of the lease, but the court limits the landlord to just one section of the agreement. Finally, the court permitted the landlord to sue tenant periodically as the amount of damages becomes certain.
A good bit of the court’s time is spent deciphering the lease. As the court noted, correctly, “the amount of damages owed by [tenant] ultimately turns on the terms of the parties’ lease.” In essence, the court attempted to determine which of the remedies the landlord was entitled to exercise under the lease and constituted acceptable damages in light of the acceptance of surrender. 16 Cobalt highlights a lease issue that has been discussed in many cases and in Friedman on Leases: the effect of an acceleration provision in the context of a breach of a commercial lease.
The lease contained the following pertinent provisions:
13.3. Landlord's Rights on Event of Default. On the occurrence of any Event of Default, the Landlord may ... take any or all of the following actions, inter alia:
13.3.1. re-enter and repossess the Premises and any and all improvements thereon and additions thereto;
13.3.2. declare the entire balance of the Rent for the remainder of the Term to be due and payable, and collect such balance in any manner not inconsistent with applicable law;
13.3.4. relet any or all of the Premises for the Tenant's account for any or all of the remainder of the Term ... in which event the Tenant shall pay to the Landlord, at the times and in the manner specified by the provisions of Section 2, the Base Rent and any Additional Rent accruing during such remainder, less any monies received by the Landlord, with respect to such remainder, from such reletting, as well as the cost to the Landlord of any attorneys' fees or any repairs or other action (including those taken exercising the Landlord's rights under any provision of this Lease) taken by the Landlord in account of such Event of Default;
…
13.3.6. pursue any combination of such remedies and/or any other remedy available to the Landlord on account of such Event of Default under applicable law.
The landlord expressly invoked section 13.3.2, although in its supplement to motion for default, the landlord relied also on section 13.3.4. in its specific request for damages to cover leasing commissions and tenant improvements incurred as a result of tenant’s breach. The tenant argued that section 13.3.4 exclusively governed the determination of damages.
Section 13.3.2 accelerates rent upon default of tenant. The landlord argued that the provision was enforceable and permitted the landlord, upon the tenant’s default, “to collect all past and future rent in a single damages payment.” Apparently, this was an issue of first impression in the District, at least as argued by the parties and determined by the court. The court states: “nor has the Court located any District authority directly on point.”
The court looks to the Restatement (Second) of Property – Landlord & Tenant 12.1 cmt. k. According to that comment, a landlord has the choice of accelerating the rent and giving up the right to terminate the lease (unless, on later terminating for a default, the landlord reimburses the tenant for accelerated rent that tenant paid,) or terminating the lease, and giving up the right to future rents pursuant to the acceleration clause. There is no in-between position. The parties in 16 Cobalt terminated the lease by agreement in which the landlord accepted surrender. As a result, the court concludes, the landlord gave up its right to accelerate.
Although it denied Section 13.3.2 acceleration, the court permitted the landlord damages under Section 13.3.4., which allows landlord damages “equal … to the amount of rent [the tenant] would have owed in rent had it remained in possession through the end of the Lease term, plus any reletting expenses; less … the security deposit and the rentals that the [landlord] receives from reletting, as well as the cost to the Landlord of any attorneys' fees or any repairs or other action (including those taken exercising the Landlord's rights under any provision of this Lease) taken by the Landlord in account of such Event of Default.”
Section 13.3.4 would permit damages for lost rent. However, in 16 Cobalt, the landlord was not able to find tenants to take all of the premises for the remainder of the tenant’s terms. The court stated that “it is premature to grant damages as to future lost rent” until such time as it is clear what these damages will be. In other words, because the landlord had a duty to mitigate, and because some of the space was not yet leased, the landlord could still reduce the amount tenant owes landlord in damages if it secures additional replacement tenants. As a result, the court required landlord to bring a second suit at some point in the future.
The court would have been willing to grant damages to landlord for rent from the date of termination of the lease to the date of the December 8 order, because this amount was possible to fix. (After all, it is clear at that point in time the exact portion of the space taken by replacement tenants.) According to the court, it was “unable to do so on the current record, as [landlord] has not provided the Court with the precise amount of rentals obtained throughout this period.”
The landlord made the interesting argument that it had no real duty to mitigate damages at all. The landlord argued that it is up to the tenant to argue the landlord’s duty to mitigate as an affirmative defense to landlord’s claim for damages. The landlord noted that the tenant failed to raise the defense, or any response, in the initial round of filings. Rather than address the underlying issue of whether mitigation is an affirmative defense, the court rejected the landlord’s argument on a narrower procedural ground. The court states “this is not a case where [the tenant] filed an answer that failed to assert an affirmative defense, but rather where the [tenant] filed no answer and was found liable pursuant to a default judgment.” According to the court in 16 Cobalt, this does not constitute a true waiver. The landlord was therefore required to mitigate.
The court has an easy time of it with respect to the landlord’s costs of reletting the premises vacated by tenant. The court grants landlord reimbursement for the not inconsiderable attorneys’ fees and leasing commissions associated with reletting the space and finding the tenants. Further, the court reiterated that the tenant owed plaintiff past rent actually incurred.
Comment 1: Friedman on Leases Section § 5:3 (Randolph ed. 2008) discusses acceleration provisions in detail. Two general approaches to these provisions are common. According to Friedman on Leases:
There is some confusion concerning the concept of acceleration of rent because some jurisdictions and some leases use the term to describe what might better be described as the contract remedy for anticipatory breach. Under this remedy, the landlord has the right to recover the balance of the rents owed (brought down to present value) because, by its present breach, the tenant has indicated that it also intends to breach the future lease obligations as well. … Other jurisdictions refer to the acceleration right as a right to collect rent over the balance of the term, and do not view this rent as contract damages. In some of these jurisdictions, landlords are prohibited from collecting rent and also regaining possession for the lease term. In such jurisdictions, the landlord may not terminate the lease, by reentry or repossession, without losing the right to the accelerated rent. Nor may he collect rent for the entire term under acceleration clause and recover possession before t
he expiration of the lease. Many cases state that a landlord who obtains passion from the tenant loses his right to accelerated rent.
Id. at 5-40. The District of Columbia would seem to fall into the latter category that views acceleration provisions as conferring the right to collect rent over the balance of the term.
Comment 2: Although dicta, footnote 2 to the case provides a clear warning to landlord attorneys drafting rent acceleration provisions for space in D.C. The court states that, although such provisions may be enforced, they will be invalid if over broad. Citing 49 Am.Jur.2d Landlord and Tenant § 583 (2006), the court explains that acceleration provisions should not be deemed “per se valid,” The court further explains “that courts have in fact found acceleration clauses to be invalid unenforceable penalties where the Landlord is permitted to trigger the clause for any breach of the contract, no matter how trivial. [Citation omitted.] Here, the acceleration clause in the parties' Lease may be invoked by Plaintiff “on the occurrence of any Event of Default,” Lease at § 13.3, which in turn is defined as including the Tenant's failure to “perform any of its obligations under the provisions of this Lease,” id. at § 13.1 (emphasis added). Accordingly, it appears that the acceleration cl
ause at issue may be invoked for any breach by Defendant and is therefore an unenforceable penalty.” Lawyers drafting these provisions to be governed by D.C. law would be wise to limit the language of acceleration clauses to monetary obligations of tenant, and perhaps to “material” non monetary defaults.
Comment 3: The court’s analysis of Section 13.3.4 accurately follows D.C. precedent cited in the case. The district court quotes the D.C. Court of Appeals in Lennon v. United States Theater Corp., 920 F. 2d 996 (D.C. Cir. 1990):
District of Columbia law provides a landlord with three options in the event of a wrongful abandonment. First, he may accept the abandonment and thereby terminate the lease. If the landlord does so, the obligation of the tenant to pay future rent ceases, but the tenant is still liable for any damages specified in the contract as a remedy for its breach. Second, the landlord may relet the premises and hold the tenant liable for any deficiency in the rent, without acquiescing in the abandonment. However, under District law, a lease provision giving the re-entering lessor a right to lost rent is construed as creating a right to damages, subject to the mitigation doctrine. The landlord's third option is to allow the premises to remain vacant and to hold the tenant for the full rent.Id. at 1000 (emphasis added.)
The court in 16 Cobalt therefore states that Section 13.3.4 created a damages remedy and not as rent: “In this case, Plaintiff accepted the abandonment, as evidenced by the Surrender Agreement signed by the parties, and is therefore entitled to damages under the Lease. The Lease provision permitting Plaintiff to relet the Leased Premises and hold the tenant liable for lost rent is properly construed as creating a right to damages.” 16 Cobalt, 2008 WL 5135633 at 5.
That said, one might question an aspect of the language in the Lennon decision, quoted by the court in 16 Cobalt. The second option referred to in Lennon essentially says that the landlord may treat the lease as in full force and effect and relet for the benefit of the tenant. This is normal and accepted lease law. However, this anticipates that tenant has vacated the space and landlord finds a replacement tenant. Why should it matter that landlord enters the space in order to install the replacement tenant pursuant to a provision in the lease? In fact, one might think this lease provision necessary to allow the landlord to legally relet the space for the benefit of tenant. Entering the space without the tenant’s permission might otherwise be deemed a trespass. The important point is that in 16 Cobalt, the landlord did not simply re enter the space pursuant to a provision in the lease, but rather, the landlord re entered because it had accepted surrender and execu
ted an agreement for this purpose. This terminated the lease. It is this fact alone that makes any demand by landlord for “rent” inappropriate, and renders the landlord’s demand for any money is in fact a demand for damages.
It seems that D.C. case law suggests something quite a bit more aggressive: any provision in a lease allowing reentry to relet will defeat the ability of landlord to relet for benefit of tenant. It is hard to see how this can be truly what the court means.
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