Leases Must Expressly Permit Landlord Damage Claims

It is not uncommon for commercial landlords to believe that they are entitled to recover all fees and expenses directly related to a tenant's breach of its lease. Indeed, the provisions that describe the damages a landlord may recover in these situations are typically quite broad. Nevertheless, landlords should realize that clear, limiting language in a lease can cost them in court.

A recent decision by the state of Washington federal bankruptcy court points up the danger of this kind of restrictive language (F & N Acquisition Corp. 152 Bankr. 304 [1993]). Though this case was decided in bankruptcy court, the legal principles are quite relevant to leases.

On August 6, 1991, the tenant's predecessor, F & N, as lessee, entered into a lease with the landlord to become an anchor tenant in an Everett, Washington, mall. The lease contained an operating covenant requiring the lessee to continually operate a department store on the premises for 20 years.

Under article 29 of the lease, the remedy for default of any provision of the lease was termination of the lease or reentry and reletting. The same article provided that "no action shall be maintained against Tenant by Landlord...on account of this Lease except (i) for the recovery of the specific sums required to be paid by Tenant by the express terms of this Lease, (ii) for the recovery of the damages and other relief provided for in this Article XXIX, and (iii) to enjoin Tenant from performing an act prohibited by the express provisions of this Lease." The only damages provided for by article 29 were "the reasonable cost of obtaining possession of the F & N store and reletting same, including, but not limited to, advertising costs, commission for reletting, legal, architectural and other professional fees, and any repairs and alterations necessary to prepare it for reletting."

When F & N went bankrupt, a retail store called Mervyn's obtained an assignment of the lease from F & N in the bankruptcy proceedings. Monetary defaults and rent arrearage were paid when the lease was assumed and assigned, and Mervyn's continued to pay the rent and other monetary obligations from that point forward.

The landlord contended that article 29 should have been read to permit recovery of expenses incident to any transfer of the tenancy, including the assignment that had taken place, not solely a transfer resulting from the landlord's retaking. Thus, without conceding that the lease may not have permitted the full range of consequential damages flowing from the vacancy of the store, the landlord asserted that it was at least entitled to damages of the type listed in article 29.

In that regard, the landlord sought recovery of approximately $91,700 based on the following: $20,000 in attorney's fees; $14,200 for maintenance in connection with the transfer to Mervyn's; $20,000 in security costs incurred between the time F & N vacated and Mervyn's took possession; $22,500 for administrative expenses created by the transfer to Mervyn's; and $15,000 for advertising and marketing incurred "to preserve the Everett Mall as a viable entity until such time as Mervyn's could commence business operations."

The landlord asserted that the limitation of damages contained in article 29 should be declared null and void, because its ability to pursue its limited remedies under the lease was frustrated by the tenant's conduct-the assignment after the filing of a petition in bankruptcy. Although the language contained in the lease seemed to describe a fairly broad range of possibilities, the court construed that language to mean that the only other damages authorized under the lease were the expenses incurred in reentry and reletting. Because the landlord did not pursue this remedy, the court ruled that the lease expressly disallowed the damages the landlord claimed. In denying the landlord's request, the court found that the lease limited damages strictly to the actual expenses involved in retaking and reletting, and there was nothing in the language of article 29 or any other term of the document that supported a more expansive construction.

In its argument, the landlord focused on the operating covenant, apparently requiring the store to remain open for 20 years. When F & N closed its doors to the public, the landlord maintained, that covenant was breached. However, from the language of the lease as well as the circumstances of the parties, the court concluded that a breach of the operating covenant was intended to be an event of default only and not a basis for damages. The court could not find any reason to conclude that the parties intended to treat a breach of the operating covenant any differently from any other kind of breach. The lease provided the landlord with the same remedies whether the tenant failed to pay rent or abandoned the premises.

Whether the parties truly contemplated a breach of the operating covenant was thus irrelevant. What was clear was that they intended a strict limitation on damages in the event of a default of any kind. Furthermore, assuming the tenant had abandoned its operations without bankruptcy, the store could have been dark for many months before the landlord could have relet the premises. In that event, the landlord's damages would still have been limited to the expenses of retaking and reletting.

By limiting the damages to the lessor by express language in the lease, the parties agreed, either expressly or tacitly, to apportion the risk rather than placing it all on the anchor tenant. The tenant's predecessor apparently had sufficient bargaining power to obtain this clause.

Careful drafting of the damages clause and other provisions of a lease may help to avoid these kinds of decisions. Landlords will want to be more careful about the concessions they grant in leases. Anticipation of the problems that a default could cause may help a landlord to recover against a defaulting tenant.

Hanon W. Russell, CCIM, JD

Hanon W. Russell, CCIM, JD, is a partner in the firm of Cantor, Floman, Russell, Gross, Kelly, & Amendola, P.C., located in Orange, Connecticut. Russell can be reached by phone at (203) 795-1211 or by e-mail at hwr@chesscafe.com. The discussion of legal issues involved in this column is for informational purposes only. Results may vary depending on state laws and particular facts.