Massachusetts Court Upholds Liquidated Damages in Commercial Lease

On April 15, 2016, Cummings Properties, LLC (Cummings) entered into a five-year lease with a company controlled by Daryl Hines (Hines).  The lease provided that should Mr. Hines’s company miss a payment, after a ten-day grace period and notice to Mr. Hines, Cummings was permitted to collect, as liquidated damages, the entirety of the remaining rent due on the five-year lease. Mr. Hines also provided a personal guarantee.

The worst imaginable scenario played out.  Mr. Hines’ business lost a crucial contract and failed to pay rent one month into its five-year lease. One year later, Cummings found a new lessee for a four-year term. It nonetheless sought to collect the full amount of its liquidated damages.  A trial court awarded Cummings $68,650 in damages.  An intermediate appellate court reversed, finding that, because the liquidated damages provision failed to account for the possibility that Cummings would find a new tenant, it operated as an unenforceable penalty.

In Cummings Properties, LLC v. Hines, Massachusetts’ Supreme Judicial Court reversed, reinstating the $68,650 judgment. The substance of the opinion begins, reasonably enough, with freedom of contract.  The parties agreed to a liquidated damages provision, so they should be bound by it.  However, if the court determines that the provision is actually a penalty, well then, not so much.  Courts can evaluate the nature of the clause using the “single-look approach,” which focuses on the state of play at the time of contracting or the “second-look approach,” considering matters at the time of breach.  Massachusetts opts for the former, as the second seems to the court an invitation to opportunistic litigation.

Applying its single-look approach, the court asks whether damages would be difficult to ascertain ex ante and whether the amount of liquidated damages was a reasonable estimate of actual damages.  Hines failed the first prong because he failed to present any evidence in support of his argument that it was entirely foreseeable that Cummings, a high-volume commercial landlord, would find a new tenant.  As to the second prong, Massachusetts has long allowed such liquidated damages provisions in lease agreements.  Hines alleged a lack of sophistication, but the trial court found him to be sufficiently sophisticated to understand the liquidated damages provision, and the Supreme Court deferred to that determination.

I see no reason to enforce a liquidated damages provision in these circumstances.  It either encourages landlords to leave their premises empty to no good purpose, taking real estate off the market and increasing prices for tenants generally, or it provides them with a windfall.  The clause seems on its face a penalty, designed to discourage breach. The landlord gets paid the full lease amount, in advance and without any adjustment for the expenses associated with maintaining the property.  The clause gives the landlord every incentive to encourage its tenants to breach, especially when the market is tight and the landlord is confident that they can find a new tenant.  They can then collect rents from the new tenant and try their luck going after the former tenant.  The duty to mitigate is there for a reason, and I see no reason for a special judicial carve-out designed to protect what, in almost every imaginable case, would be the dominant party.

Given the framing of the issue as a matter of freedom of contract and its limitations, it would be an interesting project to apply Rebecca Stone‘s and Hanoch Dagan‘s theories of freedom of contract to the problem of liquidated damages.