In El Centro Mall, LLC v. Payless ShoeSource, Inc., (174 Cal.App.4th 58, Cal. App. 4 Dist., April 21, 2009), a California Court of Appeal considered whether a liquidated damages clause in a commercial lease was enforceable after the tenant broke the lease. The Court of Appeal held that the liquidated damages clause was presumptively enforceable and the tenant failed to prove that the liquidated damages was a penalty.
Payless ShoeSource, Inc. (“Payless”), entered into a commercial lease in 1990 with the predecessor in interest of El Centro Mall, LLC (“Mall”). The lease was originally for ten years, but Payless ultimately extended the lease for another five years. The extended lease was set to expire on December 31, 2005. Payless leased 3,300 square feet of space in a shopping center owned by Mall. The base rent was $4,950 but Payless was also required to pay additional percentage rent based on its gross sales.
Under the lease, Payless agreed to be open for business for certain hours each day. The lease also provided that, if Payless fails to operate within the lease’s terms, including the stipulated hours of business, Mall shall be entitled to collect an additional daily charge. This charge was set at 10 cents per square foot of Payless’s floor area or $100, whichever is greater, for each day that Payless “fails to commence to do or to carry on business as herein provided, such additional charge is a liquidated sum representing the minimum damages which Landlord is deemed to have suffered…” Due to lagging sales, Payless had not paid the additional percentage rent since 1999. On March 4, 2005, Payless closed its business operations. Payless continued to pay its base rent, but did not pay liquidated damages as provided for in the lease. Payless refused to pay the amount due under the liquidated damages provision because it alleged the provision was an unenforceable penalty under Civil Code section 1671 and was arbitrarily applied to Payless.
Mall brought a lawsuit against Payless to recover the amount due under the lease for liquidated damages. The trial court found in favor of Mall and awarded it $90,226.80 in damages.
The Court of Appeal held the trial court did not err in finding that Payless was required to pay Mall the amount due under the liquidated damages provision. Civil Code section 1671, subdivision (b), provides, “[A] provision in a contract liquidating damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.” The court held Payless did not meet this burden.
The reasonableness of the provision must be judged “at the time the contract was made and not as it appears in retrospect.” The validity of a liquidated damages provision is not dependent on the amount of damages actually suffered. All the circumstances existing at the time the contract was entered into must be considered to determine if the liquidated damages provision is reasonable.
The court concluded that the liquidated damages provision provided for in the lease between Mall and Payless would be an unenforceable penalty if it was only used as a basis for estimating percentage rental damages because the lease already contains a basis for calculating damages for loss of percentage rental. The additional liquidated damages provision, therefore, would be unnecessary because it would only serve to penalize Payless. Here, however, Mall maintains that the provision does more than compensate for loss of percentage rental. Mall contends that the liquidated damages provision also covers other damages such as “the anticipated loss of synergy, goodwill, and patronage Payless provides by continuing to operate in the retail center.” Mall claims that, because Payless is a national tenant, it generates foot traffic to the shopping center. Covenants of continuous operation for national chains are a way to help guarantee such foot traffic. “Because it is difficult to estimate the amount of damages from the loss of synergy, goodwill, and patronage accompanying the breach of the continuous operations covenant by a national tenant, such as Payless, the landlord will typically require a reasonable liquidated damages calculation.” The theory is that the amount of business a retail tenant may generate in synergy or goodwill is proportional to the amount of retail space utilized by the tenant.
The court held that Payless failed to present evidence that the 10 cent per square foot charge did not represent a reasonable estimate of the damages that Mall would suffer if Payless ceased operations, and that Payless failed to meet its burden of showing that the amount of liquidated damages was not a reasonable estimate of damages. Accordingly, the Court of Appeal affirmed the judgment of the trial court.
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