The California Court of Appeal, Fourth District, recently upheld a liquidated damages clause in a commercial lease, which was enforced due to the tenant’s breach of a continuous use covenant. In El Centro Mall, LLC v. Payless Shoesource, Inc. (May 21, 2009, G040038), Payless, a shopping-center tenant, closed its store before the expiration of its lease term. The lease included a liquidated damages clause, which provided that if the tenant did not continuously operate its business, tenant would be required to pay landlord 10 cents per square foot of the premises for each day that tenant did not operate. Although Payless continued to pay rent, it refused to pay the liquidated damages, arguing it was an unenforceable penalty.
Civil Code section 1671(b) governs the enforceability of a liquidated damages clause. In 1977, the California legislature deleted the presumption that a liquidated damages clause in a commercial context was invalid, and replaced it with a presumption of validity, thus shifting the burden to the challenging party to prove the provision was unreasonable. In a commercial lease context, a liquidated damages clause is proper if the damages for breach of the covenant cannot be reasonably determined at the time the lease is entered into, but that the amount is a reasonable estimate of the damages that would be incurred by landlord.
In El Centro, the landlord argued that the liquidated damages in this “continuous use” context were intended to reimburse landlord for the loss in goodwill and patronage at the shopping center if Payless ceased operations. Since that amount was not easily determined, the parties included a liquidated damages clause to reasonably estimate the amount of damages for such breach. The standard for determining the amount of liquidated damages in this context is based on the theory that a tenant’s prospective generation of patronage, synergy, goodwill and sales to the retail center, is directly proportionate to the amount of space the retail tenant leases. The tenant contended that the liquidated damages provision was arbitrarily included in some, but not all, of the other tenants’ leases at the shopping center, regardless of the other tenant’s size and gross sales, thus it could not be a reasonable estimate of potential damages.
The court held that a liquidated damages clause could be an unenforceable penalty if the evidence showed that the liquidated damages provision was included arbitrarily in other tenants’ leases at the center, and not based on distinctions in the amount of damages that would be incurred by landlord due to the amount of space leased and the stature of the tenant. However, in this case, Payless did not provide sufficient evidence to the court to meet that burden. This case illustrates that courts will uphold a liquidated damages clause in a “continuous use” context, but the liquidated damages clause amount must be a reasonable estimate of damages at the time the lease was signed, based on the amount of space leased and the stature of the particular tenant.
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