Rent Abatement Clauses: Tenants Should Speak Softly, But Draft a 'Club'

'Liquidated damages constitute the compensation which the parties have agreed must be paid in satisfaction of the loss or injury which will flow from a breach of contract.' (Wirth & Hamid Fair Booking, Inc. v. Wirth, 265 N.Y. 214, 223 (1934)). In determining whether liquidated damages constitute a penalty, courts have historically focused on three areas of inquiry: 1) the intention of the parties (United States v. Bethlehem Steel Co., 205 U.S. 105, 119 (1907)); 2) the ability of the parties to ascertain in advance damages flowing from a future breach (Ward v. Hudson River Bldg. Co., 125 N.Y. 230, 235 (1891)); and 3) the reasonableness of the amount stipulated (Wise v. United States, 249 U.S. 361, 365-367 (1919)). Although the intention of the parties was once considered a fundamental area of inquiry, this has been abandoned in modern case law. More recently, liquidated damages clauses have been upheld if the amount of damages can be considered a reasonable measure of the probable loss that a party would incur, and if it would be very difficult, or impossible, to determine the actual loss in the event of a breach. (Truck Rent-A-Center v Puritan Farms 2nd, 41 N.Y.2d 420 (1977)). A rent abatement clause providing for an amount that is 'plainly or grossly disproportionate to the probable loss' will be treated as a penalty and will not be enforced because 'public policy is firmly set against the imposition of penalties or forfeitures for which there is no statutory authority.' (Id. at 424). Additionally, courts review the provision as of the date of the contract, not as of the time of the breach. (Walter E. Heller & Co. v. American Flyers Airline Corp., 459 F. 2d 896, 898 (2d. Cir. 1972)).

In a free market society, it seems odd that parties may freely bargain over the terms of performance included in a contract, but are limited in their ability to bargain over remedies for breach of those same terms. In order to preserve a client's contractual expectations, due care must be taken in crafting a rent abatement clause. In Wise v. United States (249 U.S. at 365 (1919)), Justice John H. Clarke opined: 'There is no sound reason why persons competent and free to contract may not agree upon this subject as fully as upon any other, or why their agreement, when fairly and understandingly entered into with a view to just compensation for the anticipated loss, should not be enforced.' Further, '[t]he parties to the contract, with full understanding of the results of delay and before differences or interested views had arisen between them, were much more competent to justly determine what the amount of damage would be, an amount necessarily largely conjectural and resting in estimate, than a court or jury would be, directed to a conclusion, as either must be, after the event, by views and testimony derived from witnesses who would be unusual to a degree if their conclusions were not, in a measure, colored and partisan.' (Id. at 367). However, in the 88 years since Wise was published, courts have taken an active roll in deciding whether bargained-for liquidated damages are actually penalties. In the context of rent abatement clauses, counsel must ensure that the parties make rational distinctions between varying degrees of potential harm that could occur from various contract breaches, so that upon adjudication, a court will determine that the bargained-for remedy was not conspicuously disproportionate to the foreseeable loss, and therefore is not a penalty.