Last week the Supreme Judicial Court of Massachusetts (SJC) held that, despite defaulting only one month into its five-year lease, a commercial tenant is bound by a liquidated damages clause requiring a lump-sum payment of all rent due during the remainder of the lease term. As set forth in Cummings Properties, LLC v. Hines, Massachusetts Constable’s Office Inc. (MCO), entered into a five-year office lease with Cummings Properties, LLC (Cummings). The defendant Hines, the founder and sole director of MCO, personally guaranteed MCO’s lease obligations, including full payment of rent. One month into the term, MCO lost an important business contract and failed to pay rent the following month. Cummings began eviction proceedings in the state District Court, and one year after MCO vacated the premises, Cummings entered into a four-year lease with a new tenant.
Cummings filed suit in Superior Court against Hines to enforce his obligations as guarantor of the lease. The lease contained a liquidated damages clause that provided the entire balance of rent for the lease term would become due and payable “as liquidated damages, since both parties agree that such amount is the reasonable estimate of the actual damages likely to result from such breach.” The lease did not contain any language limiting damages in the event the space was re-let.
A Superior Court judge upheld the enforceability of the liquidated damages clause. Hines appealed and the Appeals Court reversed, concluding that the provision was an unenforceable penalty because it didn’t account for the fact that Cummings could (and in fact did) re-let the space and mitigate its damages. Cummings then appealed to the SJC.
In its decision, the SJC cited the basic rule of freedom of contract and deference to those who willingly enter into legally enforceable contracts. Massachusetts courts have long enforced liquidated damages clauses “so long as they are not disproportionate to anticipated damages as to constitute a penalty.” The court explained that the enforceability of a liquidated damages clause is often analyzed under either the “single look” approach, which looks at the circumstances at the time of contract formation, or the “second look” approach, which allows for an after-the-fact assessment of actual damages to avoid a windfall to the non-breaching party.
Massachusetts has adopted the “single look” approach because it promotes certainty, defers to the expectations of the contracting parties, and is more likely to lead to the resolution of disputes without litigation. As the SJC said, a second look approach encourages an aggrieved party to litigate in an effort to contest the damages awarded under a liquidated damages clause in the hope of obtaining some relief. The court concluded that a liquidated damages clause like the one in the Cummings lease that awards the agreed rental value of the property at the time of breach is a “reasonable anticipation of damages that might accrue from nonpayment of rent.” Where experienced business parties have negotiated a liquidated damages clause, the court declined to read into the contract a duty to mitigate or offset for future re-letting where the contract is silent on such terms.
The SJC’s decision might cause commercial landlords to rejoice over the prospect of not only recovering full rent from a defaulting tenant, but also obtaining future rental proceeds from a new tenant. While this kind of broad liquidated damages clause might be the new starting point in future leases, it’s hard to imagine a well-represented tenant with any leverage agreeing to such an onerous clause. A sophisticated tenant will likely seek to negotiate a liquidated damages clause that caps liability at rent for some number of months, or a lump-sum payment that represents the excess of rent for the remainder of the term less the fair market rental value of the premises at the time of breach. This kind of concession is all the more critical if you are negotiating a lease for 10 or 15 years, or if your client is personally guaranteeing the lease. The SJC’s decision, however, ignores the plight of small commercial tenants who may lack leverage and have no choice but to accept this kind of liquidated damages clause. The lesson for commercial landlords and tenants from Cummings is clear: the words of the contract matter and the unwary tenant (or personal guarantor) who simply skims over a lease document before signing does so at great risk.