New York Court of Appeals Update (December 2020)

This was originally posted on the SGR blog.

Court Nixes Grossly Disproportionate Liquidated Damages:

Landlord Not Entitled to $1M+ for Tenant Default of $175K

The Court of Appeals recently considered the enforceability of a liquidated damages provision in a commercial lease Surrender Agreement between  Columbia University, one of the City’s premier universities, and D’Agostino Supermarkets, a family-owned food market chain founded in 1932. As a general matter, parties are free to agree to a liquidated damages clause provided that the clause is neither unconscionable nor contrary to public policy.

But were the damages sought by Columbia grossly disproportionate to the amount due from D’Agostino upon full performance of the Surrender Agreement? Supreme Court and the Appellate Division struck the provision as an unenforceable penalty in contravention of public policy. D’Agostino appealed.

RIVERA, J.(for the Court)

The Trustees of Columbia University and  D’Agostino Supermarkets, Inc., entered a 15-year commercial lease for the supermarket’s rental of the ground floor and basement levels of a building owned by Columbia. Thirteen years into the tenancy, with D’Agostino facing financial difficulties, the parties entered a Surrender Agreement that terminated the lease in exchange for surrender of the premises and a staggered payment of $261,751.73.

The Surrender Agreement provided, in relevant part,

In consideration of Landlord entering into this Surrender Agreement, Tenant shall pay to Landlord (i) concurrently herewith an amount equal to Forty-Three Thousand and 00/100 Dollars ($43,000.00) (the `Initial Surrender Payment’), (ii) on or before June 1, 2016, an additional amount equal to Forty-Three Thousand and 00/100 Dollars ($43,000.00) (the `Second Surrender Payment’) and (iii) on the first day of each month during the period commencing on July 1, 2016, and ending on and including May 1, 2017, Fifteen Thousand Nine Hundred Seventy-Seven and 43/100 Dollars ($15,977.43) (each such monthly payment described in this clause (iii), a `Monthly Surrender Payment’).

In the event of D’Agostino’s defaulted or failed to timely cure upon notice, the Surrender Agreement further provided that:

the aggregate amount of all Fixed Rent, additional rent or other sums and charges due and payable during the term of the Lease shall immediately thereafter come due and payable by Tenant to Landlord and [] Tenant shall no longer be entitled to be released and relieved from and against any Released Claims . . . . TIME SHALL BE OF THE ESSENCE with respect to the dates set forth in this Section.

As agreed by the parties, D’Agostino vacated and surrendered the premises  to Columbia within days of signing the Surrender Agreement and timely made two $43,000 surrender payments. The premises was relet one month after the surrender.

D’Agostino thereafter failed to timely pay four monthly surrender payments, from July to October 2016, despite Columbia’s notice to cure. In November 2016, Columbia sued to enforce the damages provision in the Surrender Agreement. After D’Agostino answered, Columbia moved for summary judgment on the complaint seeking future payments under the terminated lease, i.e., $1,020,125.15, plus interest and other taxes and costs provided for under the lease.

Columbia rejected D’Agostino’s December 2020 tender of $175,751.73, which represented overdue and early payments of the remaining surrender installments. D’Agostino cross-moved for summary judgment striking the damages provision and seeking entry of judgment against itself for $175,751.73—the outstanding amount due under the Surrender Agreement—along with accrued interest as of October 14, 2016, or, in the alternative, denying Columbia’s motion and ordering discovery on the issue of damages and mitigation based on the new lease.

Supreme Court denied Columbia’s motion for summary judgment and granted D’Agostino’s cross-motion for summary judgment for the requested amount and interest. The Appellate Division affirmed. Columbia appealed to the Court of Appeals.

Columbia argued that the Surrender Agreement was a practical resolution of D’Agostino’s breach of their commercial lease and so Columbia’s damages should be measured against D’Agostino’s default on the lease. In the alternative, Columbia requested remand for a hearing to determine Columbia’s actual damages.

D’Agostino countered that the liquidated damages provision was grossly excessive and effectively a late fee of over 2000% per annum for failure to timely pay the monthly installments. And also contended that Columbia’s actual damages were readily calculable and accounted for when the parties entered into the Surrender Agreement.

The Court of Appeals concluded that the damages were properly measured against D’Agostino’s breach of the Surrender Agreement and not, as Columbia and the dissent maintained, against the breach of the terminated lease. Viewed in that light, the Court of Appeals further concluded that the liquidated damages provision was an unenforceable penalty because it was plainly disproportionate to the damages for the only contractual breach—overdue payment of the monthly surrender installments.

In accordance with the parties’ commercial tenancy, in the event of a breach, Columbia had two options: either  allow D’Agostino to maintain possession of the property for the full lease term and hold it liable for past and future rent; or reenter the premises and collect all rent due up to the time of reentry. If it chose to reenter, Columbia could relet the premises and D’Agostino would be liable for any deficiency in rent and other related expenses.

Instead of suing for a breach of the lease, the parties negotiated and entered into the Surrender Agreement, which provided that, on the date of surrender, the lease “and the term thereof and all rights of [D’Agostino] thereunder shall expire and terminate.” It further relieved D’Agostino of its obligations under the lease, including payment of future rent and costs, in exchange for payments of certain fixed amounts totaling $261,751.73 and its surrender of the premises.

In other words, and as was commonly understood of these arrangements, the Surrender Agreement constituted a new contract between the parties that terminated the lease and all prospective obligations flowing from the tenancy. The new contract also included a liquidated damages provision. Liquidated damages are an estimate, made by the parties at the time they enter into their agreement, of the extent of the injury that would be sustained as a result of breach of the agreement.

A liquidated damage provision has its basis in the principle of just compensation for loss. Liquidated damages that constitute a penalty, however, violate public policy, and are unenforceable. A provision which requires damages grossly disproportionate to the amount of actual damages provides for a penalty and is unenforceable.

D’Agostino, as the party seeking to avoid payment of liquidated damages, had the burden of establishing that the damages for breach of the Surrender Agreement were disproportionate to the foreseeable losses and in fact, a penalty. D’Agostino met that burden.

The question was distilled to whether the liquidated damages provision in the Surrender Agreement was so disproportionate to the anticipated harm to Columbia from D’Agostino’s failure to timely pay the monthly installments that the provision constitutes a penalty. The damages provision effectively reinstated future rent liabilities under the terminated lease, in the amount of $1,020,125.15, plus interest and other prospective taxes and costs due under the lease, even though those damages did not flow from a breach of the Surrender Agreement. Those damages were 7½ times what Columbia would have received had D’Agostino fully complied with the Surrender Agreement. Columbia could not enforce a non-existent lease under the guise of damages for a breach of a separate contract.

When the lease was in effect, Columbia could have exercised its rights as the landowner and proceeded against D’Agostino for violating the leasehold terms. Instead, Columbia negotiated to terminate the lease in exchange for a set amount of money and surrender of the premises. That contract freed Columbia from its lessor obligations. Critically, contrary to the dissent’s assertion that Columbia “received nothing in exchange, it allowed Columbia to immediately reenter and relet the premises without the need for litigation, which is exactly what it did.

When D’Agostino breached the Surrender Agreement, Columbia was entitled to proceed under that contract and demand damages for the breach, including the amount past due and acceleration of the remaining installment payments. However, Columbia could not seek a payment grossly disproportionate to the amount past due plus interest. By any measure the more than one million dollars plus interest demanded was disproportionate to the $175,751.73 unpaid under the Surrender Agreement.

Columbia chose to terminate the lease in exchange for a fixed amount paid in installments and reentry on the premises for purposes of entering a new lease with another tenant. The award of outstanding payments allowed Columbia to realize the benefit of its bargain under the Surrender Agreement and put the property to its highest and best use. That approach encouraged surrender agreements as providing a benefit to all parties—the tenant was released from future liability and the landowner regained the premises and the opportunity to relet on its own account.

Columbia did not receive six payments on time, but that was the risk that it accepted by entering the Surrender Agreement. A party’s default is a risk common to all contracts, without unique effect in the context of a surrender of premises. And the existence of that risk does not and cannot justify exaction of a penalty.

Under well-established rules of contract, the Surrender Agreement’s liquidated damages provision did not fairly compensate Columbia for D’Agastino’s late payments. The provision called for a sum more than sevenfold the amount due if D’Agostino complied fully with the Surrender Agreement. The Court would not enforce such an obviously and grossly disproportionate award without offending the State’s public policy against the imposition of penalties or forfeitures for which there is no statutory authority. Accordingly, there was no error in rejecting the liquidated damages provision.

DiFIOREChief Judge (dissenting).

After D’Agostino breached the lease by failing to pay rent for more than seven months, the parties settled their dispute by entering into a Surrender Agreement which contained certain conditions. If D’Agostino made timely installment payments totaling about $262,000, representing the rent it already owed but had failed to pay, it would be relieved of certain other obligations stemming from its breach of the lease. However, if it failed to timely make the payments, D’Agostino would not be released and relieved from the claims Columbia possessed as a result of the breach of the lease, the right (as described in the Surrender Agreement) to collect “the aggregate amount of all Fixed Rent, additional rent or other sums and charges due” during the remainder of the lease term (about two years).

It was undisputed that, after entering the Surrender Agreement, D’Agostino again failed to uphold its end of the bargain, breaching the condition to timely make the back-rent installment payments. Yet the majority concluded, as a matter of law, that D’Agostino—a well-counseled, sophisticated party who freely negotiated the terms of the settlement—should be relieved of its obligation to accept the consequences of that second breach. That result was incompatible with the Court’s freedom of contract precedent and the strong public policy favoring enforcement of settlement agreements.

The public policy favoring freedom of contract applies with particular force to the Surrender Agreement—which is a settlement agreement crafted by the parties to resolve their dispute without litigation. Settlement agreements are judicially favored and may not be lightly set aside. Strict enforcement of settlement agreements serves multiple important purposes, consistent with those underlying freedom of contract. There is a societal benefit in recognizing the autonomy of parties to shape their own solution to a controversy and assurance that their agreements will be honored provides them finality and repose upon which to order their affairs. Moreover, settlement agreements are favored because they also promote efficient dispute resolution, avoiding]potentially costly, time-consuming litigation and preserving scarce judicial resources as courts could not function if every dispute devolved into a lawsuit. These policies, and the significant interests they protect, guided the resolution of this dispute between two sophisticated, counseled commercial entities.

The practical result of the majority’s holding was that Columbia University received nothing in exchange for its agreement: to give the tenant additional time to make back rent payments that were already overdue, provided those payments were timely made; and to forfeit its right to collect future rent from D’Agostino for its breach of the lease. Under the majority’s analysis, the carefully negotiated consequence of D’Agostino’s continued failure to pay the back rent was unenforceable; indeed, there was no consequence for D’Agostino’s breach of the Surrender Agreement and D’Agostino was rewarded for serial breaches of valid and binding contracts. a deviation from application of bedrock freedom of contract principles.

When the agreement was executed, Columbia possessed a right to pursue the full value of future rent payments until the conclusion of the lease term. At that time, there was no assurance that Columbia would sign a new tenant (and what costs might be incurred in that process), nor did the parties know the amount of rent Columbia might be able to negotiate or whether a new tenant would timely pay during the remainder of the original lease term. Thus, the remedy negotiated by the parties in the Surrender Agreement was directly premised on Columbia’s rights under the lease; had a reasonable relation to Columbia’s probable actual harm; and was intended to fairly compensate Columbia for that breach. Measured in a way that adequately recognized the nature of the bargain struck in the Surrender Agreement, D’Agostino did not meet its burden to show that the damages set forth in that agreement were so disproportionate as to operate as an unenforceable penalty.

It was irrelevant that Columbia’s actual damages might ultimately be different than the amount D’Agostino agreed to pay in the contingent remedy provision of the Surrender Agreement. The enforceability of a liquidated damages clause does not turn on whether the remedy that the parties contemplated before the breach occurred is identical to the damages actually suffered. To impose such a requirement would obviate the entire purpose of such provisions, which is to reasonably estimate the damages that might result, permitting the parties to avoid the costs and uncertainty of litigating damages in the event of a future breach. For this reason, the rough relationship between the remedy in the contract and the damages flowing from a breach must be assessed based on the terms of the agreement and the information the parties possessed at the time it was executed—not with the benefit of hindsight based on after-the-fact proof of damages actually incurred.

Refusing to enforce the contingent remedy that the parties contracted for in their settlement agreement injected uncertainty into commercial tenancy agreements and the settlement of disputes, increasing the parties’ transaction costs. It also rewarded a sophisticated, represented party for breaching its validly-entered agreements. That will discourage commercial landlords from agreeing to settlements of this nature, to the detriment of defaulting tenants like D’Agostino. Limiting the damages recoverable when such settlements are breached to the discounted amount provided for in the restructured contract, even in the event of a new breach, removes any incentive for landlords to agree to settle by permitting tenants who have already defaulted to default again without recourse.

Because there was nothing unfair about the settlement crafted by these well-counseled sophisticated parties, public policy afforded no basis to alter their contract. Since the back rent payments were already substantially overdue, Columbia reasonably sought assurance that D’Agostino would uphold its end of the bargain under the Surrender Agreement (something it failed to do under the lease). As reflected in the plain language of the agreement, Columbia was willing to forego pursuit of its then-existing right to collect both unpaid back rent and future rent only if D’Agostino timely made the back rent installment payments. But that was not what happened. By eliminating the element that induced the owner to give up its rights, the majority created a distorted, one-sided settlement in which—despite its default—D’Agostino was able to enjoy the full benefit of the bargain.

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