§ 14.03 Determination of Damages After Default and Termination

• Jurisdiction: United States
• Publication year: 2022

§ 14.03 Determination of Damages After Default and Termination

[1]—In General

Landlords have limited options when dealing with a defaulting tenant.¹ Very rarely can a landlord re-write an existing lease to provide itself with more protection but still elect to keep the tenant in the space and sue for rent and other damages as they accrue.² Thus, the landlord has an advantage of being able to continue to pursue its claim as rent becomes due, but has the drawback of requiring the landlord to sue periodically to collect its rents.

If a tenant is considering filing for bankruptcy protection, the landlord can choose to lower the rent as a way of keeping the tenant in business unless the situation is so dire that the landlord's single efforts will not help.

In some states, a landlord may be able to accelerate rent on a tenant's default and declare rent for the rest of the lease due and payable in a lump sum.³ However, in a number of jurisdictions, if the landlord elects to terminate the lease, it cannot then accelerate rent that would have accrued for the rest of the lease and, conversely, if it accelerates the rent, it cannot also terminate the lease since it must give the tenant possession of the premises. In these jurisdictions, if the landlord accelerates rent but the tenant is unable to pay, the landlord is left in the situation of having the tenant occupying space but paying nothing until the landlord is able to obtain a judgment for the accelerated amount and acquires the leasehold interest in a judicial sale.

When the landlord takes back the space and ends the tenancy upon the tenant's default,⁴ the landlord may be limited in its rights to collect for its loss of future rent. The landlord should review state law to determine how it may exercise its recovery rights and the right of reentry.

When a tenant files for protection under the Bankruptcy Code, the landlord's rights may be severely limited.⁵ The tenant's petition for protection acts as an automatic stay of any action against the tenant and until the bankruptcy court lifts the stay to permit the landlord's actions, the landlord cannot take any action regarding the space, including terminating the lease, reentering the space or bring a state court action to evict the tenant or recover damages from the tenant.⁶

If the landlord suspects the tenant is about to file for bankruptcy protection and the tenant is in default beyond any notice or cure periods stipulated in the lease, the landlord should use any rights it may have under the lease or state law to terminate the lease and apply its security deposit to its damages.⁷ If this termination occurs before the tenant files for protection, the landlord may be able to avoid the problem of filing an action to lift the stay in the tenant's bankruptcy proceeding in order to terminate the lease and the trustee or debtor in possession cannot assume the lease.⁸ However, if the termination does not take effect before the petition is filed, the trustee or debtor-in-possession may be either to assume the lease or eject it.⁹

The tenant's assumption of the lease may not necessarily be a bad thing for the landlord, especially when there may not be viable replacements for the tenant. If the tenant was in default before the filing, the lease cannot be assumed by the trustee or debtor-in-possession unless the default is cured,¹⁰ and the landlord is entitled to receive "adequate assurance of future performance."¹¹

If the trustee or debtor-in-possession rejects the lease, the rejection will be a breach of the lease but may not necessarily terminate the lease or dispossess the tenant.¹² The landlord may have to have the Section 362 automatic stay lifted then file a state court eviction action to terminate the lease and remove the tenant from the premises.¹³ Section 365(d)(3) of the Bankruptcy Code gives the landlord an administrative claim for rent coming due from the date of filing until the lease is rejected and the rent for this "stub period" may be entitled to priority as an administrative claim.¹⁴ The Court then analyzes the evidence submitted and determines, on a case-by-case basis, the amount of the benefit to the estate. The amount of the benefit to the estate is presumed to be the contract rate of rent. Nonetheless, the debtor can submit evidence that the benefit to the estate is lower than the contract rate. That evidence may include, but is not limited to, proof of the fair market value of rent.

The landlord's damages are limited when a lease is terminated because of a tenant's default either before the bankruptcy action is filed or because of a rejection in bankruptcy. Damages cannot exceed "the rent reserved by such lease, without acceleration, for the greater of one year, or 15% not to exceed three years, of the remaining term of such lease." Damages are calculated from the earlier of the date on which the bankruptcy petition is filed or the date on which the landlord takes back or the tenant surrenders the premises, plus any unpaid rent due (without acceleration) on this earlier date.¹⁵ This will be an unsecured claim for the landlord.

Due diligence and lease provisions that may benefit a landlord include the following:

• Review the financial statements of the tenant to assure that the tenant has sufficient assets to meet the lease obligations;

• Request a guaranty from a related entry if the tenant is a corporation or, if the tenant is owned by individuals, then a personal guaranty from these individuals;

• Ensure that the language of the lease allows the landlord to apply the tenant's security deposit to the rents due (otherwise it can be applied to the tenant-debtor's assets in bankruptcy);

• Allow the landlord to draw down on the tenant's letter of credit;

• Make the tenant liable for interest on past due rent (if it is high enough it may act as an incentive for the tenant not to default on its rent);

• Allow the landlord to reenter the space and collect rent if state law allows this remedy;

• Allow rent acceleration and call this rent "liquidated damages" This avoids the need to sue periodically for rents due;

• Note that the right to terminate the lease and proceed against the tenant for its damages is the most important default remedy.¹⁶

Of course, the landlord should always seek a tenant that is creditworthy and responsible. If there is an issue regarding creditworthiness, for example the tenant is entering into a new business, the landlord should require a guaranty of the tenant's lease obligations from an entity or person that has money or assets.¹⁷ "A properly written guaranty will make the guarantor directly liable for the obligations of the tenant under the lease (not as a 'backstop' in the event the money cannot be collected from the tenant, but as a co-obligor with the tenant)."¹⁸ By structuring the guaranty that way, the landlord will have the right to collect any damages from the guarantor as well as from the tenant.¹⁹

Finally, in some states, commercial leases can contain "confessions of judgment" for monetary damages. These clauses must be properly drafted to be enforceable. But, assuming that it is properly drafted, the confession of judgment allows the landlord when a default occurs to go to court and obtain a judgment against the tenant for the damages it would be permitted to collect under the lease without having to go through a trial.²⁰

[2]—Under the Common Law

Most leases that the authors have seen throughout the country still follow the old common law doctrine with regard to the method for collecting damages after default under a lease and termination. The common law provides that after a default requiring termination of the lease, the landlord must go into court to seek a deficiency judgment on a monthly basis after the loss of each month's rental is realized. In the event the landlord is able to mitigate its damages by locating a new tenant and substituting a new lease for the old one, then the rental income, if and when it exceeds the costs to replace the defaulting obligation, is deducted from the rental obligations that would have been paid by the defaulting tenant. Judgments in arrears are obtained for any deficiency on a monthly basis. Also under the common law doctrine, in the event that a lease is replaced with one bringing in higher rentals, any excess rentals are applied to offset all the other costs under the terminated lease and shall not revert back to the tenant.

The following example is a fairly standard default remedy clause, providing for the collection of the difference between the rent due and owing under the lease and the rents collected in the event of mitigation.

Example 2:

In the case of any such default, the rent and additional rentals shall become due thereupon and be paid up to the time of such default and Owner may relet the premises or any part of parts thereof either in the name of Owner or other successor, representative or agent of Owner for a term or terms which may at Owner's option be less than or exceed the period which otherwise would have constituted the balance of the term of this lease and may grant concessions or other free rent or charge a higher rental than that of this lease. Tenant or the legal representatives of Tenant shall also pay Owner as liquidated damages for the failure of Tenant to observe and perform said Tenant's covenants herein contained, any deficiency between the rent hereby reserved and/or covenanted to be paid and the net amount, if any, of the rents collected on account of the subsequent lease or leases of the demised premises for each month of the period which would otherwise have constituted the balance of the term of this lease. Any such liquidated damages shall be paid in monthly installments by Tenant on the rent date specified in this lease and any suit brought to collect the amount of deficiency of any month shall not prejudice in any way the rights of Owner to collect the deficiency for any subsequent

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