Legal Briefs

Beware of the Double Dip

Beware of the Double Dip in Lease Acceleration Provisions

Fans of the show Seinfeld will no doubt recall how narcissist George Costanza incurred the wrath of party guests by “double-dipping” his potato chip into the onion dip, thereby infecting the entire bowl with his germs. By analogy, landlords should avoid the double dip in certain types of acceleration clauses that may contaminate remedy provisions of their leases.

Commercial leases commonly contain one of several variations of rent acceleration provisions. The most aggressive type provides that, upon tenant default and after notice and grace periods, the landlord may terminate the lease and seek to recover as liquidated damages, all of the rent that would have become due for the balance of the term in a lump sum.

Such a clause was the subject of the 2014 case of 172 Van Duzer Realty Corp. v. Globe Alumni Student Assistance Association Inc., in which the Court of Appeals considered a commercial landlord's lease provision that sought both possession of the premises and acceleration of the remaining rent after the tenant's default and abandonment of the premises. While the court held that this acceleration clause was not per se invalid merely because the landowner terminated the lease and the tenant was no longer in possession, the court also found that the tenant was entitled to a hearing on the issue of whether the collection of undiscounted accelerated rent was an unenforceable penalty: 

“Defendants claim that because the acceleration clause permits Van Duzer to hold possession and immediately collect all rent due, the damages are grossly disproportionate to the landowner's actual damages. They contend this is a windfall that allows Van Duzer to double dip [emphasis added] -- get the full rent now and hold the property. On its face, this argument is compelling because arguably the ability to obtain all future rent due in one lump sum, undiscounted to present-day value, and also enjoy uninterrupted possession of the property, provides the landowner with more than the compensation attendant to the losses flowing from the breach even though such compensation is the recognized purpose of a liquidated damages provision."

To address concerns expressed by the court in Van Duzer, some rent clauses discount the accelerated rent to present value at some stipulated rate -- often 4 percent or a specified spread over the prime rate. While this does not eliminate the double dip, it does avoid the obvious windfall that would result from collecting an undiscounted sum. Nevertheless, even this variant is likely unacceptable to many tenants.

Favorable Options

A more reasonable -- and more enforceable -- version of rent acceleration bears a direct relationship to the actual damages suffered by a landlord in the event of a tenant's default. This type of liquidated damage provision essentially eliminates the double dip by deducting the market rental value of the premises recovered by the landlord, while also reducing the accelerated damages to the then-present value. This formula also denies a windfall recovery by the landlord if the market rental value of the space is equal to, or higher than, the rent that was payable by the tenant under the lease.

Today's competitive leasing environment -- where retail centers need to lease space to walk-in medical practices, and office buildings lease to fitness centers or day care facilities -- has prompted some landlords to explore new forms of liquidated damage/acceleration provisions associated with their  upfront build-out costs for converting this space.

Some landlords have sought to recover the unamortized cost of the landlord's work, broker commissions, and free rent in a lump sum as liquidated damages, in addition to accelerated rent for the balance of the term. This, of course, would likely be ruled as the ultimate double dip because upfront costs already are built into the rent itself. It is arguable, however, that recovery of the unamortized amount of these upfront costs without acceleration of the rent would avoid the double dip while being more reflective of a landlord's actual damages -- especially where the unique nature of the tenant improvements renders them unusable for subsequent re-letting.

Peter Marullo, Esq.

Peter Marullo, Esq., is a partner at Ruskin Moscou Faltischek  in Uniondale, N.Y., and is co-chair of the Commercial Lending Services Department and a member of the Real Estate Department. Contact him at pmarullo@rmfpc.com.

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CIRE September/October 2018

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