Rent Abatement Was Unreasonable Penalty on Owner

Facts: A shopping center owner sued one of its tenants, challenging the enforceability of lease provisions conditioning the tenant’s obligation to open a store and pay rent on a specific retailer operating a store in the center on the commencement date of the lease. It also challenged the tenant’s option to terminate the lease if the retailer ceased operations and was not replaced by another, acceptable retailer within 12 months.

The opening cotenancy condition was not satisfied. The tenant took possession of the space, never opened for business, never paid rent, and terminated the lease after the 12-month cure period expired.

The owner claimed that the tenant was obligated to pay rent for the full 10-year term of the lease because the provisions authorizing rent abatement and termination were unconscionable or, alternatively, an unreasonable penalty and thus unenforceable. The trial court agreed. A jury awarded the owner $672,100 for unpaid rent and approximately $3.1 million in other damages caused by the termination.

The tenant appealed, contending that the cotenancy provisions in the lease were not procedurally and substantively unconscionable and were not an unreasonable penalty.

Decision: A California appeals court modified the decision to award damages only for unpaid rent; it upheld the decision as modified. 

Reasoning: Unconscionability requires proof of both procedural and substantive unconscionability. The appeals court concluded that the evidence established there was no procedural unconscionability because the parties were sophisticated and experienced in commercial lease negotiation, their negotiations involved several drafts of the letter of intent and subsequent lease, and the owner’s decision to approach the tenant first about renting the space was a “free and unpressured choice.” The tenant’s insistency on cotenancy provisions during negotiations didn’t make the lease a contract of adhesion or otherwise deprive the owner of a meaningful choice.

The appeals court also stated that as a general rule, a contractual provision is an unenforceable penalty under California law if the value of the property forfeited under the provision “bears no reasonable relationship to the range of harm anticipated to be caused if the provision is not satisfied.”

Here, the trial court’s determination that the rent abatement provision constituted an unreasonable penalty was supported by its findings that: (1) the tenant did not anticipate it would suffer any damages from the retailer not being open on the lease’s commencement date; and (2) the value of rent forfeited under the provision was approximately $39,500 per month. There was no reasonable relationship between $0 of anticipated harm and the forfeiture of $39,500 in rent per month, and therefore, the rent abatement provision was an unenforceable penalty, the appeals court determined.

As to the lease termination provision, California courts have adopted a specific rule that holds no forfeiture results from terminating a commercial lease based upon the occurrence of contingencies that: (1) are agreed upon by sophisticated parties; and (2) have no relation to any act or default of the parties. That was true here: The termination provision did not constitute a forfeiture so the termination provision did not create an unreasonable penalty, the appeals court pointed out.

• Grand Prospect Partners, L.P. v. Ross Dress for Less, Inc., January 2015