By Douglas M. Bregman, Esq.
Some leases for commercial property contain provisions calling for the payment of damages by the breaching tenant, calculated by accelerating all future rents owed under the remaining lease term. Although the general concept of liquidated damages provisions had previously been broached at the appellate level in Maryland, no appellate decision to this point has addressed specifically acceleration of rent provisions.
In 2009, the Circuit Court for Montgomery County, Maryland, heard the case of Saul Holdings Limited Partnership, et al. v. Raquel Sales, Inc and Barefeet Enterprises, Inc., which involved actions for breach of lease and breach of guaranty on simultaneous commercial tenancies entered in Georgia and Maryland. Following Raquel Sales' breaches, the aggrieved landlords sought restitution for unpaid and accelerated rent due under the leases, presenting the court with the opportunity to adjudicate the validity of such damages provisions. Because the case involved separate commercial leases for properties in Georgia and Maryland, the court evaluated the validity of the accelerated rent provisions in the contracts pursuant to the law of the respective states. However, without prior Maryland appellate case law to guide its evaluation of the provision in the Maryland lease, the court's consideration was one of first impression, and thus offers insight into how similar clauses may be weighed in future actions under commercial leases
Given the novelty of the decision in Maryland jurisprudence, this article will review and analyze the Circuit Court's opinion. First, it will begin with a brief background of the facts in the case of Saul Holdings, including the terms of the lease agreements providing for accelerated rent upon tenant default. Next, the Saul Holdings opinion will be presented and analyzed, beginning with its application of Georgia law, and moving on to its use of existing Maryland legal authority to disallow the validity of the acceleration clauses in that case. The next discussion will concern the case law regarding accelerated rent provisions in certain selected states. Finally, looking forward, the article will draw upon the reasoning in the Saul Holdings opinion as to how future accelerated rent provisions may be crafted to be enforceable.
Saul Holdings Background and Lease Terms
In January 2006, Raquel Sales, Inc. ("RSI") entered into two separate Shopping Center Retail Leases as a commercial tenant. The first lease was consummated with Saul Holdings, L.P. ("Saul") for retail space in the South DeKalb Plaza Shopping Center ("DeKalb Lease") in Decatur, Georgia. The second lease was with Briggs Chaney Plaza, L.L.C. ("Briggs Chaney") for retail space in the Briggs Chaney Shopping Center ("Briggs Chaney Lease") in Silver Spring, Maryland. Barefeet Enterprises, Inc. executed a Guaranty to each of the leases on behalf of RSI, by which it assumed liability for all payments and obligations in the event of RSI's failed performance.
Aside from differences in the agreed-upon minimum monthly rental payments owed under the respective leases, the two agreements contained substantially identical terms and provisions. Both leases covered a tenancy of ten years, required the payment of minimum monthly rent and miscellaneous maintenance, use, and tax charges, and provided for annual increases equal to 102 percent of the preceding year's rent. Each lease also contained an accelerated rent provision, granting the landlord the right to seek "liquidated damages" upon default by the tenant. The damages were calculated as the sum of all monthly rents owed, multiplied by the remaining months of the contractual tenancy, and discounted to present value at a rate of six percent, less any credits for rent received from re-letting the property. The acceleration clause thereby provided a mechanism by which the tenant would be liable for rent payments on the leased premises for the entire term, regardless of whether it had abandoned the property prior to the expiration of that contractual period.
For unspecified reasons, RSI abandoned the DeKalb premises in August 2007, and subsequently failed to make payments due under the lease after October 2007. Similarly, RSI paid the required rent for the Briggs Chaney premises through November 2008, but thereafter ceased to make its lease payments and ultimately abandoned the property in January 2009. Although Saul was able to re-let the DeKalb premises to another commercial tenant in April 2009, there is no indication in the trial record that Briggs Chaney secured a new lease following RSI's abandonment.
Under the DeKalb Lease, Saul sought to recover the lost rent for the months between the abandonment of the premises and the subsequent re-letting, as well as payments for the two years remaining on RSI's original lease term following the expiration of the new tenant's lease. Briggs Chaney, on the other hand, sought the accelerated payment of all rents due for the remaining seven years of the Briggs Chaney lease.
Saul Holdings and the Validity of Acceleration Clauses in Georgia and Maryland
Although the Circuit Court largely dismissed the claims for damages under the leases, it nonetheless recognized that the case law of Georgia and Maryland supports the contracting parties' right to provide for continued tenant liability for after-accrued rent. Thus, despite refusing to award the full damages sought, the court stopped short of declaring similar contract clauses unenforceable in all circumstances, opting instead to define the test against which future acceleration provisions would be measured. Turning first to the DeKalb Lease in Decatur, the opinion reviewed the standard developed by the Georgia courts to weigh the validity of accelerated rent provisions in lease agreements.
Accelerated Rent Provisions Under Georgia Law
As noted above, the Maryland Circuit Court recognized that although tenants are typically not otherwise responsible for rent payments once a lease is terminated, Georgia case law supports the contracting parties' option to include provisions in a lease agreement obligating the tenant to pay after-accrued rent. Such provisions were not uniformly enforceable, however, and the Georgia courts generally applied the test defined by the state's Court of Appeals in the 1992 case of Peterson v. P. C. Towers, L.P. to determine the validity of accelerated rent damages.
Peterson involved a dispossessory proceeding to recover past-due and accelerated rent on a commercial lease with nearly two years remaining on the original five year tenancy. Following the tenant's failure to pay rent, the landlord evicted the deficient party and exercised the option in the lease agreement to recover accelerated rent for the remainder of the lease term. After affirming the right of a landlord to seek such payments pursuant to an explicitly detailed provision in a lease, the court held that the clause was enforceable only if the amounts sought qualified as liquidated damages, rather than a penalty.
An accelerated rent provision qualifies as enforceable liquidated damages if it satisfies three prongs: (1) the injury from a tenant's breach is difficult or impossible to accurately estimate; (2) the parties intend to provide for damages, rather than for a penalty; and (3) the stipulated sum is a reasonable pre-estimate of the probable loss incurred.
The injury suffered due to a tenant's breach is calculated as the difference between the rent otherwise owed for the remaining tenancy and the fair rental value of the premises for that same term. Thus, to satisfy the first prong, it must be exceedingly difficult to accurately assess appropriate damages, taking into consideration the future fair market value of the premises and the probability of re-letting the property. Where more than a year and a half remained on the original lease term, the court believed the estimation of damages caused by the tenant's breach was sufficiently difficult to ascertain, thereby satisfying this prong.
To satisfy the third prong, the reasonableness of the estimated damages hinges upon the parties' accounting for the present value of future rent owed, changing market conditions for the remainder of the original lease term, and the probability that the premises will be re-let at a later time. While the Dekalb Lease accounted for the present value of future rent, it failed to account for, or adjust to, any other future consideration. The court also made note that the two year period for which the plaintiffs sought acceleration was not to become due until five years in the future, a timeframe the court believed to be too distant to bear any reasonable relation to actual damages. The court therefore found that the acceleration provision failed the third prong of an enforceable liquidated damages provision.
Acceleration Rent Provisions Under Maryland Law
Maryland law generally provides that lease obligations, including payment of rent, are extinguished once a lease is terminated. However, Maryland law also provides an exception whereby contracting parties may impose liability for rent, damages or deficiency arising in the case of re-letting. Maryland courts have not directly answered whether accelerated rent provisions are allowed under this exception. But, similar to Georgia courts, courts from other states have framed their analysis in the context of whether accelerated rent provisions constitute valid liquidated damages or fail as a penalty.
An accelerated rent provision is enforceable as a valid liquidated damages clause if (1) the sum agreed upon is a reasonable forecast of the just and fair compensation for the harm that would result by a breach of the contract and (2) the resultant injury is difficult to estimate accurately or actual damages could not be easily ascertained.
Maryland courts have found liquidated damages provisions to be difficult to estimate or ascertain when the damages were incapable of estimation at the time of contracting. The court concluded that the accelerated rent provision of the Briggs Chaney Lease passed the second prong of an enforceable liquidated damages provision. Where the breach occurred a mere ten months into a ten year lease and a portion of the rent is based on a percentage of the tenant's gross monthly sales, the court found it difficult if not impossible to estimate damages that would result from breach.
Under the first prong, Maryland courts have found liquidated damages provisions to be a reasonable forecast of just and fair compensation for harm that results from breach if it provides a fair estimate of potential damages at the time the parties entered into the contract. The court found that the Briggs Chaney Lease was not a fair estimate of potential damages because it provided for payment of rent for approximately seven years in the future, a term the court considered far too long to estimate reasonable damages, while also awarding possession of the premises to Briggs Chaney.
The court also made note that the accelerated rent provision was contrary to Maryland law requiring mitigation of damages which would require Briggs Chaney to make all reasonable efforts to minimize its loss from the breach by finding a new tenant. Specifically, the court found that the acceleration provision created a disincentive for Briggs Chaney to mitigate its damages and instead encouraged them to rely on the judgment of the court. The court therefore rejected the plaintiff's argument that Biggs Chaney's duty to mitigate upon RSI's default would alleviate concerns about awarding a lump sum payment of future rent.
Accelerated Rent Provisions, Selected States (Virginia and Massachusetts)
Virginia courts recognize the legitimacy of accelerated rent clauses and, similar to Maryland and Georgia, analyze the validity of such clauses in the context of liquidated damages. Virginia courts have found liquidated damages provisions valid if the amount "is not out of all proportion to the probable loss." However, a liquidated damages provision that provides for an amount that is "grossly in excess of actual damages," or where the actual damages may be calculated, will be deemed a penalty and found unenforceable.
In Teachers' Retirement System of the State of Illinois v. American Title Guaranty Corp. a Virginia Circuit Court adopted reasoning similar to that of the Georgia Court of Appeals in Peterson v. P. C. Towers, L.P. to find an accelerated rent provision invalid. Specifically, the court found that the lease failed to reasonably estimate the probable loss resulting from the tenant's breach of contract, that is, it failed to account for future market conditions or the probability of re-letting the property. The court also expressed concern with the potential windfall the landlord-plaintiff would receive if the accelerated rent provision were upheld, specifically that the landlord would receive future rent from the tenant-defendant while being in a position to re-letting the premises, therefore potentially collecting double rent.
Massachusetts courts have recently taken a slightly different approach to accelerated rent clauses. Similar to other jurisdictions, Massachusetts courts also frame their analysis in the context of liquidated damages. A valid liquidated damages provision must be difficult to ascertain and must be a reasonable forecast of damages expected to occur in the event of a breach at the time of contracting, otherwise it is considered a penalty and will be found unenforceable. Massachusetts courts differ from others in that they appear more likely to find such provisions enforceable in commercial leases because they reflect the intended agreement between two sophisticated parties. Moreover, Massachusetts courts have placed the burden of demonstrating that an acceleration provision fails to properly consider future conditions on the tenant-defendant, and, for lack of adequate proof as to the contrary, have also found a liquidated damages amount for the agreed rental value of a property for the remainder of a lease to be a reasonable anticipation of damages.
Writing an Enforceable Accelerated Rent Provision
As a general matter, courts have found accelerated rent provisions to be unenforceable to the extent that they allow landlords to collect future rents in excess of probable damages that would result from the tenant breach. Courts also appear less likely to uphold acceleration clauses as the period for which a landlord-plaintiff seeks to recover extends further into the future because the ability to reasonably estimate damages diminishes and likelihood that a landlord can mitigate its damages increases. Courts are also almost universally opposed to enforcing an acceleration clause if it results in the landlord-plaintiff gaining possession of the premises as well as a lump sum payment of future rents.
However, courts appear to look more favorably upon accelerated rent provisions that allow for some flexibility and discounting of damages by accounting for future conditions, i.e. future market conditions, probability of re-letting the premises, and discounting the future stream of rents to present value. Courts also appear to favor acceleration provisions that require the landlord to mitigate damages by finding a new tenant and call for the reduction of damages in the case that the property is re-let.
While courts offer little guidance on the specifics of how to craft an acceleration clause that properly accounts for future conditions, it behooves landlords to seek no more than the present value of accelerated rents further adjusted and/or discounted for a reasonable future rental value for the remaining lease term. An attempt to recover a straight line depreciated value of all future rents through an acceleration provision may be received by courts as an attempt by the landlord to overreach for damages and may result in no future damages being awarded.
Douglas M. Bregman is the Managing Partner and founder of the Bethesda firm of Bregman, Berbert, Schwartz & Gilday, LLC