Edward M. Bloom
To
understand the importance of last December’s Appeals Court decision, Cummings Properties,
LLC v. Hines, 102 Mass. App. Ct. 28,
we must begin with a review of prior decisional law.
For more than 100 years, a Massachusetts lease has been deemed an
estate in land. When a lease is terminated due to a tenant’s default, this unique law governs a landlord’s remedies and damages. Following lease termination, the estate is returned to the landlord and so no further rent is due from the tenant, unless the lease specifically provides otherwise.
Therefore,
unlike the common law contract rule, which provides the non-breaching party
with benefit of the bargain damages, without any need for the document to spell
out the non-breaching party’s remedies, a Massachusetts commercial lease must
specifically contain a landlord’s remedies and damages upon lease termination.
Otherwise, the landlord will not be entitled to any damages or remedies. Even when
the SJC, in 2013, in the case of 275 Washington St. Corp. v. Hudson River
lnt’I, definitively agreed that a commercial lease is a contract, rather
than a conveyance of property, the Court saw no justification to change the
common law to provide a landlord with a benefit of the bargain remedy, insisting
that the century-old practice of spelling out a landlord’s damages and remedies
in the lease would not be changed. The case basically held that “a landlord
left without a remedy following a breach of the lease by a tenant has only
itself to blame for entering into a lease that fails to provide such a remedy.”
To
address this anomaly, the leasing bar, representing both commercial landlords
and tenants, has traditionally provided one or more of the following landlord’s
remedies upon a tenant’s default:
To terminate the
lease, but require the tenant to continue to pay monthly rent for the balance
of the term, notwithstanding the lease termination, with an offset for any
rent, less expenses, which each landlord receives from a substitute tenant. This
remedy would require the landlord to sue the tenant from time to time for
accrued but unpaid rent and would typically not be very practical.
A second common
remedy would allow the landlord, after termination of the lease, to collect a
lump sum calculated as the difference between the lease rent and the fair
market rent as of the date of the termination, over the balance of the term,
discounted to present value. This remedy provides the landlord with the benefit
of the bargain relief typical of contract damages and is considered a partial
acceleration of rent. For example, if the lease rent were $35 per square foot
and the fair market rent at lease termination were $30 per square foot, the
landlord would be entitled to a lump sum equal to $5 per square foot for the
remainder of the original lease term, discounted to present value. However, if
the fair market rent at the time of termination were greater than $35 per
square foot, the landlord would be entitled to no damages.
To protect the
landlord in the application of this prior remedy, many landlord lawyers provide
a third option of a liquidated damages amount equal to anywhere from six months
to two years rent, depending on the negotiating strength of each party.
However, in a dramatic 2007
jurisprudential shift, in Cummings Properties, LLC v. Nat’I Communications
Corp., the SJC held that a full acceleration of future rent upon a tenant
default under a commercial lease is valid and not an illegal penalty.
In this case, Cummings Properties included
in its standard lease form a provision that, in the event of an uncured default
in the payment of rent, the “entire balance of rent which is due hereunder
shall become immediately due and payable as liquidated damages.” The commercial
leasing bar had almost never used this type of acceleration clause because of
the 1942 SJC case of Comm’r of Ins. v. Massachusetts Accident Co. that
held that a full acceleration of rent in such a situation constituted a
penalty.
The district court in Cummings
upheld the acceleration clause, and, upon appeal to the Appellate Division of
the District Courts, credit is due to Judge Robert V. Greco, who, in
recognizing the decades-old precedent of the Comm’r of Insurance case,
admitted that “there is some level of discomfort in vacating [the lower court
decision] in reliance on a case decided only a year after Ted Williams hit
.406.” Yet, despite his misgivings, his opinion upheld the 1942 case as still
being the law of Massachusetts.
But
the SJC, in its eagerness to embrace the concept that a liquidated damages
clause in a commercial agreement should be upheld, overruled the Greco opinion
and stunned the real estate bar. In so doing, the SJC ignored its own prior
case law and cited other authorities not supporting its conclusion. The SJC,
claiming that Cummings Properties “urges us to update our jurisprudence in
light of the near unanimous trend toward upholding liquidated damages clauses
in agreements between sophisticated parties” agreed that “the rule against
penalty clauses … has come to seem rather an anachronism, especially in cases
in which commercial enterprises are on both sides of the contract.”
The SJC had previously upheld liquidated damages clauses
in purchase and sale agreements; in the 1999 case of Kelly v. Marx, the
Court ruled that a seller was entitled to retain a defaulting buyer’s five
percent deposit as damages, even though the seller resold its property for more
than the defaulting buyer’s price. The typical deposit under such agreements
ranges between five and ten percent of the purchase price. By analogy, the use
of a full acceleration clause as liquidated damages under a lease would be
comparable to permitting a seller to recover the entire purchase price as
liquidated damages under its purchase and sale agreement and then turn around
and sell the property to someone else. In the 1966 case of Security Safety
Corp. v. Kuznicki, the SJC held that liquidated damages providing for a
penalty of one-third of the contract price was unreasonable and unenforceable
as a matter of law. Clearly, a tenant default in year two of a five-year lease
allowing acceleration of three or four years of rent exceeds the one-third
standard of Security Safety.
In
1956, the SJC, in A-Z Servicenter v. Segall, ruled that an acceleration
of future interest under a defaulted promissory note is deemed a penalty even
if the note recites that such acceleration is payable as liquidated damages and
not as a penalty. The 2007 Cummings case once again ignored this prior holding
in reaching its decision.
While
the real estate bar was hoping that the SJC might reconsider or modify its
regrettable 2007 Cummings decision, it doubled down on its holding a year
later in the 2008 case of NPS, LLC v. Minihane, where it upheld an
acceleration clause in a ten-year license agreement for luxury seats at
Gillette Stadium. To make matters worse, the Court stated that, if a contract
contains an enforceable liquidated damages provision, the duty to mitigate is
irrelevant and should not be considered in assessing damages.
In
the intervening 15 years, both the leasing bar and the lower courts have
wrestled with the Cummings holding in various ways. Most landlord leases
do not contain full acceleration clauses because the commercial leasing bar has
deemed that remedy too draconian, and when a landlord like Cummings does
include that remedy, tenant attorneys will advise their clients to seek another
landlord or will try to put a cap on the full acceleration clause of one or two
years, again depending upon the parties’ negotiating strength.
And the lower courts have also tried to maneuver around
the Cummings rule, realizing the extreme exposure a defaulting tenant faces.
For example, in the 2011 case of Panagakos v. Collins, the trial court,
on remand from the Appeals Court, held that because the accelerated rent
provision was in addition to and not in lieu of all other remedies, the
provision was not a valid liquidated damages provision and would not be
enforced.
These
cases are all a prelude to the December Appeals Court decision of Cummings
Properties, LLC v. Hines, the central topic of this article.
Once
again, Cummings Properties rented space to a small commercial company, which,
in this case, provided constable process services. The new company had secured
a contract with the Department of Revenue and decided to move from Salem to
Woburn, where the DOR is located. Without a lawyer, the tenant signed a lease
for five years at $1365 a month. Within a month after the lease was executed,
the DOR suspended its contract with the company which promptly defaulted on its
rent payment in the second month of the lease. Cummings terminated the lease
and, using its accelerated rent clause, obtained a judgment of approximately
$74,100.
About
10 months after the original default, Cummings relet the tenant’s premises for
a four-year term. Notwithstanding the reletting, Cummings then sued Hines, as
guarantor of the lease, for the entire accelerated rent. The trial court,
feeling bound by the SJC’s prior Cummings decision, enters a judgment
for Cummings in the amount of $82,143, comprising damages, prejudgment interest
and costs.
Hines
appealed claiming that, under Cummings, the liquidated damages clause
can only apply if the tenant is sophisticated. The trial judge found that Hines
had no prior experience negotiating leases, was not represented by counsel and
did not actually understand all of the lease terms, including the acceleration
clause. Nevertheless, the judge concluded that Hines was sufficiently
sophisticated to be held to the terms of the lease. The Appeals Court noted
that there was no guidance or test under Massachusetts law on the issue of
sophistication, but avoided the issue by concluding the acceleration clause is
unenforceable on other grounds.
The
Court restated the rule in Cummings that a liquidated damages provision
will generally be enforced if (1) at the time the agreement was made, potential
damages were difficult to determine; and (2) the clause was a reasonable
forecast of damages expected to occur in the event of a breach. Focusing on the
second condition, the Court found that at the time of the contract formation, a
reasonable estimate of expected damages would have included either some
accounting of any rent received from a new tenant or some discounting of the
stipulated damages to reflect the likelihood of reletting.
Inasmuch
as the Cummings lease clause permitted Cummings to retake possession of
the premises, relet it and collect rent from a new tenant, AND recover all of the
remaining rent owed by the defaulting tenant, without having to account for the
rent received from the new tenant, the lease clause bears no reasonable
relationship to expected damages, and is thus unenforceable as a penalty. The
Court cited cases from numerous other jurisdictions and sources, including the Restatement
of Property and Am. Jur., to buttress its holding.
To
clarify the wisdom of the Appeals Court decision, and to delineate the
distinction between a partial acceleration clause that is typically found in
most commercial leases and the Cummings full acceleration clause, the following
example is set forth:
If the lease rent
were $35 per square foot and the fair market rent at lease termination were $30
per square foot, the landlord would be entitled to $5 per square foot for the
remainder of the lease term (discounted to present value) under the partial
acceleration clause.
Under the Cummings
full acceleration clause, the landlord would be entitled to $35 per square foot
for the remainder of the lease term (discounted to present value) AND $30 per
square foot from any new tenant that leases the defaulting tenant’s premises.
This result is clearly a windfall for the landlord and has no reasonable
relationship to the landlord’s benefit of the bargain damages.
Cummings
has appealed to the SJC, which accepted the case and oral arguments were held
on May 3rd. There were three amicus briefs: one each by the New England Legal
Foundation and the New England Patriots, both advising the Court to overrule
the Appeals Court, and a third by REBA and the Abstract Club, requesting the
SJC to uphold the Appeals Court.
At the oral argument, both parties and several judges referred to and discussed the REBA and Abstract Club brief. It is difficult to determine at this time how the SJC will decide. We can only hope that the Court, recognizing the basic unfairness and miscalculation of its original Cummings decision, overrules or modifies its 2007 decision.
A
former president of REBA and founder of the Association’s Commercial Leasing
Section, Ed Bloom is a recently-retired partner of Sherin and Lodgen LLP, where
his practice concentrated in commercial real estate with particular emphasis on
leasing. From 2001 through 2021, Ed was the editor and coauthor of MCLE’s
treatise on Lease Drafting in Massachusetts. Currently, he co-chairs the
REBA Amicus Committee. This article is based on remarks he offered at a meeting
of the Abstract Club on May 15th.
The
REBA and Abstract Club amicus brief in the pending Cummings case was authored
by the Co-chairs of the Association’s Commercial Leasing Section, Tom Bhisitkul
and Mike Riley.
