Breach-of-Lease Damages are Invalid

Facts: A building owner leased space to a restaurant tenant for a five-year term. During the course of renegotiating the lease at the end of the term, the tenant gave the owner a personal written guaranty. The lease provided for accelerated rent if the tenant breached the lease. The restaurant closed, and the tenant left the premises with three-and-a-half years remaining on the lease. The owner posted a sign at the building, noting that the property was available for lease. Although he occasionally received calls from interested parties, the owner didn't lease the space to another tenant. Aside from the monthly rent, the owner incurred other damages due to the default on the lease, including unpaid utility bills and maintenance charges. The owner sued the tenant for breach of the written guaranty.

The tenant argued that the owner had a duty to mitigate—that is, minimize—its damages from the breach by making reasonable efforts to find another tenant. According to the tenant, the owner's sign and its acceptance of phone calls inquiring about the available space weren't sufficient mitigation efforts.

The court ruled in favor of the owner. However, in determining the amount of damages the tenant owed to the owner, the trial court considered the owner's supposed failure to mitigate his damages. The owner appealed.

Decision: A Massachusetts appeals court reversed the decision and vacated the damages award.

Reasoning: The appeals court ruled that a contract provision, such as the lease provision here, clearly and reasonably establishing liquidated damages should be enforced—so long as it's not so disproportionate to the owner's anticipated damages as to constitute a penalty. That is, a lease provision specifying that a tenant in breach of the lease must pay liquidated damages is valid, but only if the damages aren't disproportionate to a reasonable estimate of the actual damages likely to result from a breach.

The appeals court noted that the issue in the case wasn't whether the owner should have made a better effort to mitigate damages from the tenant's breach of the lease. The issue was whether the steeply accelerated rent constituted a penalty because it was disproportionate to a reasonable estimate of the actual damages from the breach—that is, lost rent at the originally agreed-upon rent payment amount and some utility bills. Here, the accelerated rent the tenant was required to pay after it moved out of the space was substantially higher than the actual amount that the breach could cost the owner.

Because the lower court incorrectly considered the owner's failure to mitigate when it determined the damages from the breach, the appeals court reversed the decision in favor of the owner, vacated the damages award, and sent the case back to the lower court for further proceedings. The appeals court specified that at any future proceedings, the tenant has the burden of proving that the accelerated rental figure constituted a penalty by being disproportionately higher than a reasonable estimate of actual damages.

Panagakos v. Collins, November 2011