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River Road Associates v. Chesapeake Display and Packaging Company, Inc.

104 F. Supp.2d 418 (D. N.J. 2000)

LEASES; LIQUIDATED DAMAGES—A provision giving a landlord the right to extend a lease term if the lease would otherwise expire at a time when a tenant default remains uncured may be an unenforceable liquidated damages penalty.

A commercial lease provided that upon its termination, a tenant certified that, to the best of its knowledge, “(i) the Premises will be in material compliance with all then current laws and regulations and (ii) there will exist no material structural defect in the premises.” It also required that the tenant provide an engineering report before the lease termination so as to determine whether a material structural defect existed in the premises or if the premises were otherwise not in material compliance with all laws and regulations. If there were such defects, the tenant was required to remediate them and if the remediation would extend beyond the term of the lease, the landlord had the option to reinstate the lease until the work was completed. The tenant vacated the premises without providing the engineering report. The landlord then obtained its own report which showed material structural defects. The parties entered into a settlement agreement resolving all claims between them with the exception of the landlord’s claim for rent until the defects were remedies. At a hearing in which the parties sought summary judgment, the tenant argued that the provision granting the landlord the option to reinstate the lease was an unenforceable penalty provision. The landlord argued that it wasn’t and also argued that even if the Court found that the provision represented a stipulated damages clause, it would nonetheless be enforceable because it satisfied New Jersey’s criterion for enforceability. The Court dismissed the landlord’s arguments that the lease provision made no reference to the phrase “liquidated damages” and that the paragraph in question did not contain any provisions relating to remedies in case of breach. In doing so, the Court pointed out that New Jersey law does not rely on a formalistic requirement for specific identifying language and also that the lease had a provision in its “damages provision” which expressly provided that “no right or remedy herein conferred ... is intended to be exclusive of any other right or remedy herein or by law provided, ... .” Under New Jersey law, a provision that provides for the payment of specified damages in the event of breach is classified as a stipulated damage clause. Here, the provision granting the landlord the option to reinstate the lease “was intended to serve as a method by which the parties could set a fixed amount of damages (the amount of rent that would have been due under the lease) if Tenant breached this provision by failing to deliver a premises free from material defects.” Consequently, because the provision specified an amount of damages in the event of a specific type of breach, “the cause constitutes a stipulated damage clause… .” This did not end the analysis because “the enforceability of a stipulated damage clause hinges upon the court’s assessment of whether the provision represents a valid liquidated damage clause or an unenforceable penalty provision.” In New Jersey, stipulated damage clauses are presumptively valid and the party challenging such a clause must establish that its application amounts to a penalty. According to the Court, reasonable determination hinges upon whether the set amount “is a reasonable forecast of just compensation for the harm that is caused by the breach and whether the harm is incapable or very difficult of accurate estimate.” Further, “ncertainty or difficulty in assessing damages is best viewed not as an independent test, but rather as an element of assessing the reasonableness of a liquidated damages clause, ... ‘[t]he greater the difficulty of estimating or proving damages, the more likely the stipulated damages will appear reasonable.’” Applying those factors to the clause in question, the Court determined that it represented an unenforceable penalty provision. It found that the type of damages the reinstatement “option” sought to recover (i.e., lost profits for rent) were “not incapable of accurate estimate.” This is because “nder New Jersey law, a landlord may recover the rental value of a premises for the months in which the building remains vacant while the landlord makes reasonable efforts to mitigate damages.” Moreover, “[w]hile the finding that damages are not difficult to accurately estimate is not dispositive of unreasonableness, it necessitates a more narrow view of what represents a reasonable forecast.” Further, the Court was concerned that the provision would allow the landlord to collect monthly rent from the vacated tenant until the tenant remediated the defect. According to the Court, “[s]uch a provision is inconsistent with New Jersey law, which imposes upon commercial landlords a duty to mitigate damages.” In the Court’s view, the cited lease language relieved the landlord of its duty by allowing it to sit idly by and recover monthly rental payments without making any effort to relet or repair the premises. “This failure to address the landlord’s duty to mitigate renders the provision an unreasonable forecast of the harm anticipated in the event of a breach.” The Court was also concerned that enforcing such a provision “would violate the public policy of New Jersey by encouraging economic waste, the very concern that motivated the appellate division to extend the duty to mitigate to the commercial lease context.” Further, the Court found the provision unenforceable because “it has an in terrorem effect.” Even though the Court found the “option” portion of the lease to be unenforceable, the landlord was still entitled to go forward to prove its damages caused by the tenant’s breach of the lease.

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