Daily Development for Tuesday, November 14, 2006
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

LANDLORD/TENANT; TENANT REMEDIES; RENT ABATEMENT:  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.

 Bates Adver. USA, Inc. v. 498 Seventh, LLC, 850 N.E.2d 1137 (N.Y. 2006). 

Plaintiff Bates Advertising USA, Inc. (“Bates”) filed suit in the New York Supreme Court in December 1999 against 498 Seventh, LLC (“498”), seeking enforcement of the liquidated damages provision of the commercial lease to which plaintiff and defendant were parties.  Bates was leasing about half of a major office building in New York City.  The base rent for the 16 year term, the court noted,, exceeded $100 million.

Bates, the commercial tenant, alleged that 498, the landlord, had failed to complete certain safety and security improvements as contemplated by the lease and sought a refund of rent pursuant to a provision of the lease entitling tenant to rent abatement for every day beyond the contemplated date on which landlord had failed to complete substantially the specified improvements, with the percentage of rent abating being 50% for most improvements, and 100% for certain improvements the parties had deemed more important.  The tenant claimed that such a provision was relatively standard in significant commercial leases in New York. 

The trial court dismissed Bates’ causes of action, finding that the rent abatement provision constituted an unenforceable penalty rather than permissible liquidated damages, but the Appellate Division reversed and remanded, and on remand, the Supreme Court found that 498 had breached under the lease and awarded Bates rent abatement credits accordingly. 

The Appellate Division affirmed.  The New York Court of Appeals here affirmed as well. 
Declining to revisit the factual findings underpinning the Supreme Court’s finding of breach, the Court identified the matter at issue as whether the provision entitling tenant to rent abatement in the event of landlord’s breach was an unenforceable penalty.  Citing JMD Holding Corp. v. Congress Fin. Corp., 4 N.Y.3d 373 (2005), the Court found that the party challenging a liquidated damages clause must demonstrate either that damages for breach were readily ascertainable at the time of contract or that the liquidated damages provided are conspicuously disproportionate to foreseeable injury in the event of breach. 

The Court of Appeals noted that 498 (the landlord) had not attempted to show that damages resulting from its breach were readily foreseeable.  Further, citing the Appellate Division, the Court noted that the one-to-one proportionality between the period of breach and the period for which Bates was entitled to rent abatement successfully ensured that Bates would not obtain a benefit grossly disproportionate to its injury.  Finally, the Court rejected 498’s argument that simply because the abatement provisions were intended to incentivize or pressure 498 to complete the contemplated improvements, the provision constituted a penalty.  The Court noted that any prospect of damages for breach could be said to incentivize compliance with a party’s contractual obligations, and declined to find a penalty in the absence of damages which were grossly disproportionate to foreseeable losses.  Accordingly, the Court affirmed.

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Comment: Note that the court didn’t absolutely conclude that this provision, described as relatively standard, was in fact enforceable.  It concluded simply that, on the record, the landlord had not carried its burden of demonstrating that the provision was a penalty.  The landlord had to demonstrate either that the damages of failure to complete the safety improvements on time were foreseeable (a tough job) or that the rent abatement was not a reasonable means of estimating unforeseeable consequences.  Again, as the consequence to the tenant might be that it would be left “homeless” without being able to operate in its new space and possibly unable to continue in its old space, the 50% abatement conceivable could be regarded even as a bargain. 


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