Mitigation Under a Commercial Lease

Lawyers are celebrated for their ability to employ subtlety and finesse. However, when addressing a commercial landlord's duty to mitigate damages upon a tenant's default, it pays to be blunt.

There are still jurisdictions, including the State of New York, where the law does not impose upon the landlord of a commercial lease the obligation to mitigate its damages upon a default by the tenant, at least in circumstances in which the landlord is not contractually obligated to mitigate. Holy Properties Limited, L.P. v. Kenneth Cole Productions, Inc., 661 N.E.2d 694 (N.Y. 1995) is the dispositive case on this issue of law in the State of New York. In affirming that the landlord was not obligated to mitigate damages, the court adverted to the traditional distinction between leases, which were historically considered conveyances of interests in real property, as opposed to executory contracts, for which the law imposed an obligation to minimize injury for a breach.

Mitigation

Notwithstanding the law of New York, the prevailing trend in commercial leasing law is to require a landlord to mitigate its damages upon a default by the tenant ' at least under a lease that fails to specify that the landlord has no obligation to mitigate damages. This reflects the emerging consensus that a commercial lease should be addressed under principles generally applicable to contracts, rather than those historically applicable to conveyances. In some instances, requiring a landlord to mitigate its damages in the event of a tenant default is justified on the grounds that it is “equitable” to do so. In the view of at least some economists, this development increases economic efficiency by discouraging property from being left idle. In a case involving a default by the tenant under a commercial office lease, the Texas Supreme Court stated:

The overwhelming trend among jurisdictions in the United States has thus been toward requiring a landlord to mitigate damages '

Austin Hill Country Realty Inc. v. Smith, 948 S.W. 2d 293, 298-99 (Tex. 1997). Similarly, in a case involving a default by the tenant under a commercial office lease, a New Jersey court concluded:

In our view, reason and logic, as well as public policy, support the extension of the mitigation of damage requirements to the commercial lease setting.

Fanarjian v. Moskowitz, 568 A.2d 94, 98 (N.J. Super. Ct. App. Div. 1989) (footnote omitted).

As a practical matter, a tenant under a commercial lease will want the lease to specify that the landlord is obligated to mitigate its damages in the event of a default by the tenant. Conversely, a landlord under a commercial lease will want the lease to specify that the landlord has no such obligation. There are jurisdictions that will require, as a matter of public policy, that the landlord of a commercial lease must use reasonable efforts to mitigate damages upon a default by the tenant, if the lease is silent on this matter; and there are jurisdictions that will allow the tenant to waive the right to require mitigation by the landlord. For the careful practitioner, at least one whose client has bargaining power, the preferred practice is to have the lease specify whether or not the landlord is obligated to mitigate damages. Assuming a solvent tenant, the provisions of the lease governing damages available to the landlord in the event of a tenant's breach, and the existence of an express or implied-at-law obligation, or, for that matter, statutory requirement (see, for example, Section 1951 of the California Civil Code, Section 9-213.1 of the Illinois Code of Civil Procedure, Conn. Gen. Stat. Section 47a-11c, and Tex. Prop. Code Ann. Section 91006), for the landlord to mitigate, can be critical to the outcome of the landlord-tenant dispute.

What Happens Upon a Default?

Commercial leases frequently provide that upon a default by the tenant and recovery of possession of the premises by the landlord, the landlord has the option of: 1) periodically recovering from the tenant the deficiency between the monthly installment of rent due under the lease and the net amount (if any) recovered by the landlord from reletting the premises during such period; or 2) recovering a liquidated sum equal to the discounted present value of the rent under the lease for the balance of the term.

As noted by Jeffrey H. Newman in his article “Exit Strategies” (Real Est. Rev., Spring 1996 at 41), seeking recovery periodically (rather than accelerating the rent) carries with it certain burdens for the landlord, including the necessity of the landlord's suing repeatedly for rent deficiencies. These burdens are significantly increased if the law or the lease requires the landlord to attempt to relet the premises and mitigate its damages, which may provide the tenant sufficient bargaining power to reach a negotiated settlement with the landlord. Seeking recovery by way of acceleration eliminates the need for multiple lawsuits. However, even in such cases it could be expected that, at least in some jurisdictions, a court would imply a mitigation obligation into the lease and require deduction of the fair market value of the premises.

A Typical Clause

A typical clause proposed by a tenant requiring a landlord to mitigate damages might provide that:

Landlord shall use commercially reasonable efforts to re-let the Premises and otherwise mitigate its damages in the event of a default by the Tenant under this Lease.

Even if willing (or legally obligated) to use commercially reasonable efforts to mitigate damages, a landlord might find the foregoing clause to be unsatisfactory due to its breadth and vagueness. It is not difficult for the landlord to imagine a court imposing obligations to give preference to the re-letting of the premises in a manner that is detrimental to the landlord's business. A landlord could try to address these concerns by adding certain stipulations to its obligation to mitigate damages, such as:

• The landlord is not required to attempt to relet the premises before leasing any other vacant space at the project comparable to the premises.
• The landlord's obligation to relet the premises is subject to The landlord's reasonable business judgment concerning the best tenant mix at the project.
• The landlord is not obligated to relet the premises at a rental less than a specified percentage of the rental under the defaulted lease, or the then-fair market value (whichever is greater).
• The landlord is not obligated to relet the premises to a prospective tenant that does not meet the landlord's reasonable standards of creditworthiness.
• The landlord is not obligated to relet the premises to a prospective tenant that does not meet the requirements of any mortgage or underlying lease affecting the project.
• The landlord is not obligated to relet the premises to any prospective tenant that would impose an increased burden on the services or facilities of the project.
• The landlord is not obligated to engage any real estate broker to relet the premises other than the broker, if any (which may include an “in-house” broker), customarily utilized by the landlord, and then only on the terms customarily specified by the landlord.

How the Court Rules

The extent to which these stipulations would be enforced by a court hearing a commercial landlord-tenant suit may depend on the specific facts of the case. It has been held that the reasonableness of a landlord's efforts to mitigate damages is a question for the trier of fact (see, e.g., Borough of Fort Lee v. Banque National De Paris, 710 A.2d 1, 7 (N.J. Super. Ct. App. Div. 1998)); and the cases indicate that the obligation to mitigate requires “commercially reasonable” efforts, is driven by the particular facts of the case, and is not an absolute obligation requiring the landlord to fill the vacated premises with any willing tenant (see, e.g., Austin Hill). There is authority (such as MXL Industries, Inc.. v. Mulder, 623 N.E.2d 369 (Ill. App. Ct. 1993)), to the effect that the landlord, in attempting to mitigate damages, need not severely reduce the rent sought for the premises. At least one court, in the Borough of Fort Lee case noted above, has found that a landlord is not obligated to take action to mitigate damages that would diminish the long-term value of the premises, by renting to a lower tier of tenant.

Nonetheless, it behooves the landlord to act diligently in attempting to mitigate damages. In Fanarjian v. Moskowitz, 568 A.2d 94, 95 (N.J. Super. Ct. App. Div. 1989), for example, the appellate court affirmed the trial court's determination that the landlord had not made adequate effort to mitigate upon default by the tenant, notwithstanding that the landlord, among other efforts, placed a “for rent” sign in front of the premises, showed the premises a few times, spoke with two or other three other persons, and forwarded advertisements for the premises to some professionals journals. In Fanarjian, the trial court, after considering the entire history, found that the landlord took almost no action to attempt to mitigate for a substantial period of time prior to the trial, and took into account, among other things, that the “for rent” sign was minimal and that the “for rent” advertisements placed were minimal.

In Carisi v. Wax, 471 A.2d 439 (N.J. Dist. Ct. 1983), the court concluded that the landlord had made reasonable efforts to mitigate damages only when he consulted or engaged a broker for the purposes of re-renting the premise. In Rokalor, Inc. v. Connecticut Eating Enterprises, Inc., 558 A. 2d 265 (Conn. App. Ct. 1989), the appellate court upheld the findings of the trial court that the landlord had not made a reasonable effort to mitigate its damages when, among other things, the landlord, without justification, delayed hiring a broker for the property for several months after the tenant defaulted (although utilization of a broker to relet the premises may not be an absolute requirement, as shown in Kamada v. RX Group Ltd., 639 S.W.2d 146 (Mo. Ct. App. 1982)).

Advice to Attorneys

Given that courts in multiple jurisdictions have enforced a commercial tenant's agreement in a lease that the landlord need not mitigate damages, the careful landlord's attorney should be sure to include such an agreement by the tenant in the lease. In Sylva Shops Limited Partnership v. Hibbard, 623 S.E. 2d 785 (N.C. Ct. App. 2006), the lease simply specified that the landlord “shall have no obligation to mitigate Tenant's damages by letting the Demised Premises.” The court found that such a provision was not contrary to law or public policy and was enforceable in a commercial lease. Nevertheless, not all jurisdictions ' for example, Texas ' permit a waiver of the landlord's duty to mitigate.

In certain jurisdictions where the landlord otherwise has an obligation to mitigate, when the lease is not explicit in releasing the landlord from the obligation, courts have found that the landlord is indeed obligated to mitigate. In Carisi, the landlord was obligated to mitigate even though the lease specifically stated that the tenant would remain liable for the rent, notwithstanding any re-entry by the landlord. Similarly, in In re Cornwall Paper Mills Company, 169. B.R. 844 (Bankr. D. N.J. 1994), the court refused to find a contractual release of the landlord's obligation to mitigate damages absent a specific provision in the lease to that effect, notwithstanding that the lease provided that the failure of the landlord to re-let the premises after the tenant vacated would not release or affect the tenant's liability for damages.

Conclusion

The lesson is clear. Courts, in keeping with the prevailing trend to treat commercial leases (at least in part) as standard contractual arrangements, may require the landlord to mitigate damages upon a default by the tenant. If the landlord wishes to avoid this burden (and is not barred by law from doing so), the obligation should be expressly released in the lease.

Mark B. Rosenman is a Member in the Real Estate Department of Sills Cummis & Gross P.C. He can be reached at 973-643-5272; [email protected].

Lawyers are celebrated for their ability to employ subtlety and finesse. However, when addressing a commercial landlord's duty to mitigate damages upon a tenant's default, it pays to be blunt.

There are still jurisdictions, including the State of New York, where the law does not impose upon the landlord of a commercial lease the obligation to mitigate its damages upon a default by the tenant, at least in circumstances in which the landlord is not contractually obligated to mitigate. Holy Properties Limited, L.P. v. Kenneth Cole Productions, Inc. , 661 N.E.2d 694 (N.Y. 1995) is the dispositive case on this issue of law in the State of New York. In affirming that the landlord was not obligated to mitigate damages, the court adverted to the traditional distinction between leases, which were historically considered conveyances of interests in real property, as opposed to executory contracts, for which the law imposed an obligation to minimize injury for a breach.

Mitigation

Notwithstanding the law of New York, the prevailing trend in commercial leasing law is to require a landlord to mitigate its damages upon a default by the tenant ' at least under a lease that fails to specify that the landlord has no obligation to mitigate damages. This reflects the emerging consensus that a commercial lease should be addressed under principles generally applicable to contracts, rather than those historically applicable to conveyances. In some instances, requiring a landlord to mitigate its damages in the event of a tenant default is justified on the grounds that it is “equitable” to do so. In the view of at least some economists, this development increases economic efficiency by discouraging property from being left idle. In a case involving a default by the tenant under a commercial office lease, the Texas Supreme Court stated:

The overwhelming trend among jurisdictions in the United States has thus been toward requiring a landlord to mitigate damages '

Austin Hill Country Realty Inc. v. Smith , 948 S.W. 2d 293, 298-99 (Tex. 1997). Similarly, in a case involving a default by the tenant under a commercial office lease, a New Jersey court concluded:

In our view, reason and logic, as well as public policy, support the extension of the mitigation of damage requirements to the commercial lease setting.

Fanarjian v. Moskowitz , 568 A.2d 94, 98 (N.J. Super. Ct. App. Div. 1989) (footnote omitted).

As a practical matter, a tenant under a commercial lease will want the lease to specify that the landlord is obligated to mitigate its damages in the event of a default by the tenant. Conversely, a landlord under a commercial lease will want the lease to specify that the landlord has no such obligation. There are jurisdictions that will require, as a matter of public policy, that the landlord of a commercial lease must use reasonable efforts to mitigate damages upon a default by the tenant, if the lease is silent on this matter; and there are jurisdictions that will allow the tenant to waive the right to require mitigation by the landlord. For the careful practitioner, at least one whose client has bargaining power, the preferred practice is to have the lease specify whether or not the landlord is obligated to mitigate damages. Assuming a solvent tenant, the provisions of the lease governing damages available to the landlord in the event of a tenant's breach, and the existence of an express or implied-at-law obligation, or, for that matter, statutory requirement (see, for example, Section 1951 of the California Civil Code, Section 9-213.1 of the Illinois Code of Civil Procedure, Conn. Gen. Stat. Section 47a-11c, and Tex. Prop. Code Ann. Section 91006), for the landlord to mitigate, can be critical to the outcome of the landlord-tenant dispute.

What Happens Upon a Default?

Commercial leases frequently provide that upon a default by the tenant and recovery of possession of the premises by the landlord, the landlord has the option of: 1) periodically recovering from the tenant the deficiency between the monthly installment of rent due under the lease and the net amount (if any) recovered by the landlord from reletting the premises during such period; or 2) recovering a liquidated sum equal to the discounted present value of the rent under the lease for the balance of the term.

As noted by Jeffrey H. Newman in his article “Exit Strategies” (Real Est. Rev., Spring 1996 at 41), seeking recovery periodically (rather than accelerating the rent) carries with it certain burdens for the landlord, including the necessity of the landlord's suing repeatedly for rent deficiencies. These burdens are significantly increased if the law or the lease requires the landlord to attempt to relet the premises and mitigate its damages, which may provide the tenant sufficient bargaining power to reach a negotiated settlement with the landlord. Seeking recovery by way of acceleration eliminates the need for multiple lawsuits. However, even in such cases it could be expected that, at least in some jurisdictions, a court would imply a mitigation obligation into the lease and require deduction of the fair market value of the premises.

A Typical Clause

A typical clause proposed by a tenant requiring a landlord to mitigate damages might provide that:

Landlord shall use commercially reasonable efforts to re-let the Premises and otherwise mitigate its damages in the event of a default by the Tenant under this Lease.

Even if willing (or legally obligated) to use commercially reasonable efforts to mitigate damages, a landlord might find the foregoing clause to be unsatisfactory due to its breadth and vagueness. It is not difficult for the landlord to imagine a court imposing obligations to give preference to the re-letting of the premises in a manner that is detrimental to the landlord's business. A landlord could try to address these concerns by adding certain stipulations to its obligation to mitigate damages, such as:

• The landlord is not required to attempt to relet the premises before leasing any other vacant space at the project comparable to the premises.
• The landlord's obligation to relet the premises is subject to The landlord's reasonable business judgment concerning the best tenant mix at the project.
• The landlord is not obligated to relet the premises at a rental less than a specified percentage of the rental under the defaulted lease, or the then-fair market value (whichever is greater).
• The landlord is not obligated to relet the premises to a prospective tenant that does not meet the landlord's reasonable standards of creditworthiness.
• The landlord is not obligated to relet the premises to a prospective tenant that does not meet the requirements of any mortgage or underlying lease affecting the project.
• The landlord is not obligated to relet the premises to any prospective tenant that would impose an increased burden on the services or facilities of the project.
• The landlord is not obligated to engage any real estate broker to relet the premises other than the broker, if any (which may include an “in-house” broker), customarily utilized by the landlord, and then only on the terms customarily specified by the landlord.

How the Court Rules

The extent to which these stipulations would be enforced by a court hearing a commercial landlord-tenant suit may depend on the specific facts of the case. It has been held that the reasonableness of a landlord's efforts to mitigate damages is a question for the trier of fact ( see , e.g. , Borough of Fort Lee v. Banque National De Paris , 710 A.2d 1, 7 (N.J. Super. Ct. App. Div. 1998)); and the cases indicate that the obligation to mitigate requires “commercially reasonable” efforts, is driven by the particular facts of the case, and is not an absolute obligation requiring the landlord to fill the vacated premises with any willing tenant ( see, e.g., Austin Hill ). There is authority (such as MXL Industries, Inc.. v. Mulder , 623 N.E.2d 369 (Ill. App. Ct. 1993)), to the effect that the landlord, in attempting to mitigate damages, need not severely reduce the rent sought for the premises. At least one court, in the Borough of Fort Lee case noted above, has found that a landlord is not obligated to take action to mitigate damages that would diminish the long-term value of the premises, by renting to a lower tier of tenant.

Nonetheless, it behooves the landlord to act diligently in attempting to mitigate damages. In Fanarjian v. Moskowitz , 568 A.2d 94, 95 (N.J. Super. Ct. App. Div. 1989), for example, the appellate court affirmed the trial court's determination that the landlord had not made adequate effort to mitigate upon default by the tenant, notwithstanding that the landlord, among other efforts, placed a “for rent” sign in front of the premises, showed the premises a few times, spoke with two or other three other persons, and forwarded advertisements for the premises to some professionals journals. In Fanarjian, the trial court, after considering the entire history, found that the landlord took almost no action to attempt to mitigate for a substantial period of time prior to the trial, and took into account, among other things, that the “for rent” sign was minimal and that the “for rent” advertisements placed were minimal.

In Carisi v. Wax , 471 A.2d 439 (N.J. Dist. Ct. 1983), the court concluded that the landlord had made reasonable efforts to mitigate damages only when he consulted or engaged a broker for the purposes of re-renting the premise. In Rokalor, Inc. v. Connecticut Eating Enterprises, Inc. , 558 A. 2d 265 (Conn. App. Ct. 1989), the appellate court upheld the findings of the trial court that the landlord had not made a reasonable effort to mitigate its damages when, among other things, the landlord, without justification, delayed hiring a broker for the property for several months after the tenant defaulted (although utilization of a broker to relet the premises may not be an absolute requirement, as shown in Kamada v. RX Group Ltd. , 639 S.W.2d 146 (Mo. Ct. App. 1982)).

Advice to Attorneys

Given that courts in multiple jurisdictions have enforced a commercial tenant's agreement in a lease that the landlord need not mitigate damages, the careful landlord's attorney should be sure to include such an agreement by the tenant in the lease. In Sylva Shops Limited Partnership v. Hibbard , 623 S.E. 2d 785 (N.C. Ct. App. 2006), the lease simply specified that the landlord “shall have no obligation to mitigate Tenant's damages by letting the Demised Premises.” The court found that such a provision was not contrary to law or public policy and was enforceable in a commercial lease. Nevertheless, not all jurisdictions ' for example, Texas ' permit a waiver of the landlord's duty to mitigate.

In certain jurisdictions where the landlord otherwise has an obligation to mitigate, when the lease is not explicit in releasing the landlord from the obligation, courts have found that the landlord is indeed obligated to mitigate. In Carisi, the landlord was obligated to mitigate even though the lease specifically stated that the tenant would remain liable for the rent, notwithstanding any re-entry by the landlord. Similarly, in In re Cornwall Paper Mills Company, 169. B.R. 844 (Bankr. D. N.J. 1994), the court refused to find a contractual release of the landlord's obligation to mitigate damages absent a specific provision in the lease to that effect, notwithstanding that the lease provided that the failure of the landlord to re-let the premises after the tenant vacated would not release or affect the tenant's liability for damages.

Conclusion

The lesson is clear. Courts, in keeping with the prevailing trend to treat commercial leases (at least in part) as standard contractual arrangements, may require the landlord to mitigate damages upon a default by the tenant. If the landlord wishes to avoid this burden (and is not barred by law from doing so), the obligation should be expressly released in the lease.

Mark B. Rosenman is a Member in the Real Estate Department of Sills Cummis & Gross P.C. He can be reached at 973-643-5272; [email protected].