Commercial Landlord-Tenant—Landlord Delivered Premises Approximately One Year Late—Rent Credit Provision Was an Unenforceable Penalty—Plaintiff Is Entitled to Reasonable Damages—Successive Offers of Compromise Permitted—Landlord Entitled to Legal Fees and Costs Since Award Was Below Offer of Compromise—Neither Side Was A Prevailing Party—Severe Decline in Sales at Brick and Mortar Stores in New York City

A plaintiff retail tenant commenced an action, alleging that the defendant landlord delivered the subject premises approximately a year after the date contemplated by the lease. The lease provided that the premises would be delivered to the tenant “as a 'white box'” in August 2015, and the tenant would take an additional four months to prepare the premises for opening in December 2015 (tenant work). Following a trial, the court found that the proposed schedule was “excessively ambitious,” it was unreasonable to expect that the premises would have opened in December 2015, and the “late delivery” rent credit provision (penalty provision) in the lease bore “no reasonable relationship to any foreseeable damages” and therefore, was an unenforceable penalty. However, the court held that the tenant was entitled to reasonable damages.

The plaintiff had not accepted delivery of the premises until July 12, 2016. The court opined that the “contemplated schedule was excessively ambitious on the part of both parties and, based upon the evidence…there is no reason to believe that the store could have opened in December, 2015 under any scenario.”

The tenant characterized the penalty provision as “liquidated damages” or “an alternative means of securing performance.” The landlord argued that the penalty provision was an “unenforceable penalty” and that “the [tenant] is responsible…for much of the delay.”

The penalty provision specified that “the consequence of delay for certain periods of time would entitle the plaintiff to rent credits based on a formula that would result in the tenant being entitled to one day of free rent for each day beyond the scheduled delivery date for a period of time, thereafter two days of free rent for further delays beyond the scheduled delivery date, and, ultimately three days of free rent.” The tenant asserted that such formula provided the tenant with 825 days of rent credits, which amounted to more than $3 million in damages. The landlord had timely made a CPLR 3220/3221 offer to compromise for $1.5 million, which the plaintiff had rejected. The lease also contained a prevailing party attorney fees provision.

Although the court found that the penalty provision was an “unenforceable penalty,” the court held that the tenant is entitled to damages. The court believed that the landlord “could and should have proceeded more expeditiously with the very ambitious construction project necessary to transform two landmark buildings into a combined structure that would accommodate a high end retail facility on the first floor and the basement….” However, the court also found that “the [tenant] was responsible for a meaningful portion of the delay and…some…delay was beyond the [landlord's] control.”

The tenant is part of a large retail company. The tenant had “intensely studied the location and prepared extensive analyses of the profit potential of the contemplated location.” The court rejected the tenant's argument that damages for “a one-year delay in opening the store could not be measured.” The tenant had prepared a “comprehensive analysis” which had “targeted a return on sales for the first fiscal year of operation of $1,053,389.” That analysis was approved by the tenant's management. The tenant had also contemplated “a 'worst case' scenario” whereby the location would have “a return on sales of only $57,386 for the first year of operation.”

The court opined that even “more compelling evidence” that the penalty provision is an unenforceable penalty “as opposed to a liquidated damages provision or an alternate means of securing performance is the fact that [tenant] has insisted on the inclusion of a substantially identical 'free rent' provision in the leases for more than 100 of its stores across the country….” The court also rejected the tenant's argument that “the delay in opening [the store] had adversely affected [tenant's] online sales.” The store became operational on Dec. 5, 2016 and the store's results “underperformed the target profit” contained in the tenant's initial analysis.

Additionally, the court observed that during 2016 and thereafter, “significant adverse results were achieved at [tenant's]” other New York City locations. A comparably located store had “a 50 percent decline in sales between the fiscal year ending January, 2015 and the fiscal year ending January, 2017.” Thus, the tenant “was not immune to the severe decline in retail sales at brick and mortar stores in the New York City market.” The court further stated that the tenant had “overestimated the potential profitability” of its store and “it would be unjust to enforce a penalty…that would be grossly disproportionate to any financial harm [tenant] actually suffered from the delay in delivering the store, particularly when both parties knew or should have known that the timeline for the completion of the store established in the lease was overly ambitious.” The court found it “significant that the original letter of intent that was executed before the lease was signed provided for a lengthier time line for the completion of the 'landlord's work.'”

However, the court held that the tenant was entitled to reasonable damages. The court noted that “[t]he reconfiguration of the building,…was a complex and difficult task.” The parties had “cooperated to a certain extent and there was a course of dealing during significant times when the plaintiff made concessions to the landlord in the hope of expediting the process.” Although there had been “conflicting testimony” about “the role the installation of an elevator played in the delay” and conflicting testimony about “the extent to which the plaintiff contributed to the delay,” the court found that the landlord was “responsible for slightly less than nine months of the delay between Aug. 1, 2015 and July 12, 2016.” The court reasoned that the “most reasonable measure of damage for this delay would be to modestly discount what were demonstrated to be overly optimistic target numbers that were contained in [the tenant's internal analysis]” and awarded the tenant $650,000 plus statutory interest of nine percent from Aug. 1, 2015.

Comment: In a subsequent decision dated Nov. 21, 2017, the court addressed the prevailing party legal fee provision and offers of compromise.

The court explained:

To be considered a prevailing party…“there must be success with respect to the central relief sought”.… To justify an award of contractual attorneys' fees, a party must prevail “on the central claims advanced, and receive substantial relief in consequence thereof”….

Here, the plaintiff “primarily sought a declaratory judgment entitling it to 825 days of rent credit-the monetary equivalent of over $3 million. A declaration as to rent credits owed was, undeniably, the central relief sought by plaintiff and opposed by defendant.” The court had found the penalty provision was “an unenforceable penalty, thereby denying plaintiff the central relief sought.”

Although the tenant recovered $650,000 in delay damages, the court found that such recovery could not “in any practical sense, render [tenant] the prevailing party in this unnecessarily expensive litigation.” The tenant had recovered less than 20 percent of the damages sought, i.e., “it recovered a fraction of the relief sought while spending $660,000 in legal fees which was more than [tenant] ultimately recovered in damages excluding prejudgment interest.” The court explained that the fact that “substantially the same liquidated damages provision appears in more than 100 leases held by [tenant],” was evidence that “the liquidated damages provision…bore no reasonable relationship to any delay damages that [tenant] could claim.” The court also noted that the business conducted at the subject store had failed to meet the tenant's “overly ambitious profit expectations….”

However, the court further held that the landlord was also not a prevailing party. After observing that there is “limited case law indicating that a defendant against whom a money judgment is entered can potentially be considered a prevailing party…,” the court stated that the landlord had “willfully breached a contract” and noted that the tenant was awarded “a not insignificant monetary sum,” i.e., the landlord was held to be liable for more than $650,000 in damages plus statutory interest, and thus “cannot, in any practical sense, be considered the prevailing party.” Thus, neither party was the prevailing party.

The court also addressed offers “to liquidate damages conditionally” pursuant to CPLR 3220. CPLR 3220 “essentially enables a defendant to concede the issue of damages and try the disputed issue of liability.” “[I]f such an offer is accepted by a claimant, the only issue to be tried is that of liability, damages having already been determined by an offer and timely acceptance within ten days thereof. If a plaintiff refuses the offer, the plaintiff must not only prevail at trial on the issue of liability, but must also secure an award of damages greater than the liquidated damages figure offered by the defendant…. If the award of damages is less than the liquidated damages figure offered by the defendant, the defendant is entitled to reimbursement for the expenses of trying the damages issue, including attorneys' fees.” Moreover, “[a] defendant's offer under CPLR 3220 is best construed as a lump-sum offer which includes attendant expenses and attorneys' fees.”

In the subject case, the landlord made two timely offers pursuant to CPLR 3220. The first offer was for $1 million and a subsequent offer was made for $1.5 million. Neither offer was accepted. The court opined that “successive CPLR 3220 offers can be made.” Although the court could not “find case law to provide clarity on the issue,” it reasoned that since the purpose of CPLR 3220 was to “narrow the issues before trial and to provide a pathway to possible consensual resolution of the matter,” such purpose is “best served by allowing parties to make successive offers to liquidate damages conditionally.”

The tenant had failed to obtain a judgment greater than the landlord's CPLR 3220 offer of $1.5 million. Even if the tenant's “excessive attorney fees are included, [tenant] still failed to meet the $1.5 million threshold of defendant's CPLR 3220 offer.” Accordingly, the court held that the landlord was “entitled to the 'expenses necessarily incurred…for trying the issue of damages from the time of the offer.”

Here, the issues involving the “contractual provisions, and the nature of the declaratory relief established that the issues of liability and damages are inextricably intertwined.” Moreover, “liability was but a nominal issue compared to that of damages as it was undisputed that [landlord] failed to deliver the premises in accordance with the terms of the lease.” Therefore, the court held that the landlord was entitled to “all costs and fees incurred after its Sept. 28, 2017 offer pertaining to pre-trial preparation and the trial itself.”

The court found that the landlord's request for legal fees was reasonable in view of “the time and labor required, the difficulty of the questions involved, and the skill required to handle the problems presented; the lawyer's experience, ability and reputation; the amount involved and benefit resulting to the client from the services; the customary fee charged by the Bar for similar services; the contingency or certainty of compensation; the results obtained; and the responsibility involved.” The court awarded the landlord costs and attorney fees in the amount of $154,919.17, plus interest.

As this case illustrates, landlords and tenants will sometimes miscalculate the time necessary to obtain land use approvals or to complete contemplated construction. Lease negotiations will often address allocation of the risk of delay and the consequences therefrom.

Parties often utilize liquidated damage provisions when they believe that it would be difficult to quantify the amount of actual damages. In many instances, estimates of potential damages are “educated guesses.” The subject tenant's projections showed a significant disparity between its best and worst scenario. In certain instances, it is difficult to produce probative evidence of actual damages. Defendants typically challenge damage evidence on the grounds that, inter alia, it is speculative or that the alleged wrongful conduct was not the proximate cause of the damage. This is especially so with respect to a new store or other new business.

As a general rule, commercial parties, who are usually represented by counsel, are held to the terms of their unambiguous written agreements. Case law holds that it is not the role of the courts to re-write a contract that was imprudently entered into by a commercial party. Generally, courts will not “rescue” a party from the consequences of an agreement that it had freely entered into, because with hindsight, such agreement would result in “harsh” consequences.

The subject decision did not hold that all liquidated damage provisions that employ rent credits are illegal penalties. Rather, its holding was based on the specific evidence in the case, including the fact that such provision was apparently utilized in more than 100 stores throughout the country and the tenant had another “comparably located” store.

Free People of PA LLC v. Delshah 60 Ninth LLC, Sup. Ct., N.Y. Co., Index No. 650654/2017, decided Oct. 18, 2017 and Nov. 21, 2017, Ostrager, J.

Scott E. Mollen is a partner at Herrick, Feinstein and an adjunct professor at St. John's University School of Law.