Litigators representing landlords and tenants face a number of challenges when addressing the enforceability of an acceleration clause in a commercial lease for real property. This article offers a litigator’s perspective on the current state of the law in various jurisdictions with respect to the enforceability of acceleration clauses, damages a landlord may recover under an acceleration clause, and defenses available to a tenant.
What Is an Acceleration Clause?
Like an acceleration clause in a promissory note, a rent acceleration clause requires a defaulting tenant to pay the landlord the entire future rent due under the lease. Historically, lease acceleration clauses were intended to guarantee the landlord an immediate payoff without requiring the landlord to chase down reluctant tenants as periodic payments became due.
Acceleration clauses in leases are not new and have long been held valid and enforceable. The question then is why are these clauses so often litigated? The contention flows from the suspicion that acceleration clauses are merely unfair and disguised penalties for the defaulting tenant. This suspicion leads to litigation challenging the enforceability of acceleration clauses.
Are Acceleration Clauses Enforceable?
The general rule across several jurisdictions is that acceleration clauses are enforceable and valid so long as they do not function as a penalty against the tenant for defaulting. To this end, some courts have applied the analysis of a liquidated damages clause to an acceleration clause, with varying results on the enforceability of the acceleration clause.
The Massachusetts Supreme Judicial Court in Cummings Properties, LLC v. National Communications Corp., 869 N.E.2d 617 (Mass. 2007), took a more permissive view of acceleration clauses. According to the court, an acceleration clause is a reasonable liquidated damages clause if, at the time of entering a lease, the parties could not have foreseen (1) when in the lease term a party would breach for nonpayment, (2) the rental market at the time of the breach, (3) the cost of finding a new tenant, or (4) the length of time the property would be vacant. These inquiries under Cummings lean toward supporting acceleration clauses in a variety of factual scenarios.
On the other end of the spectrum, the Georgia Court of Appeals turned a more unforgiving eye toward acceleration of lease damages in Peterson v. P.C. Towers, L.P., 426 S.E.2d 243 (Ga. Ct. App. 1992). According to the Peterson court, accelerated rent provisions are enforceable only if
- the injury caused by breach of the lease is difficult or impossible to estimate accurately;
- the parties intend to provide for damages rather than a penalty; and
- the stipulated sum is a reasonable pre-estimate of the landlord’s probable loss.
The last element of this analysis requires a landlord to include an acceleration clause that assesses future market conditions, accounts for the probability of reletting the premises for all or part of the remaining term, and reduces the future rent to present value. The Peterson court is noticeably silent on how a landlord would draft this provision and the calculations a landlord would need to make to create an enforceable acceleration clause. See also Nobles v. Jiffy Mkt. Food Store Corp., 579 S.E.2d 63 (Ga. Ct. App. 2003). The Peterson court also took issue with a landlord who terminated a tenant’s possession of the premises but still demanded the accelerated rent, finding that such a situation would result in a windfall to a landlord who could obtain the full benefit of the lease from the defaulting tenant and potentially re-let the premises for the remaining lease term.
A recent case citing the Peterson opinion further confirms the uphill battle landlords face in crafting and enforcing an acceleration clause. In Bostick v. CMM Properties, Inc., 789 S.E.2d 211, 212 (Ga. Ct. App. 2016), the court addressed a lease provision that allowed a landlord to accelerate rent when a tenant failed to make payment. The remainder of the lease term would be made due and payable, and would be discounted to present value using a reasonable discount rate selected by the landlord. The lease even specifically stated that the accelerated rent was a liquidated damages clause and not a penalty or forfeiture. Citing Peterson, the Bostick court found that the accelerated lease clause was an unenforceable liquidated damages provision because there was no evidence that the accelerated amount was a reasonable pre-estimate of the landlord’s probable loss at the time the parties entered the lease. Specifically, the acceleration clause was found to be unenforceable because there was no reasonable estimate of the difference between the future rent due under the lease and the actual rental value of the premises for the remaining term. Because the lease did not require the landlord to assess the future market conditions and the probability of re-letting the premises, the acceleration clause was unenforceable.
Given the inequitable potential for a windfall, on which keen jurists are likely to focus, and the law on penalties, discounting future accelerated rent damages to present value may be the safest and steadiest course for drafting any such acceleration or future rent clause as well as for pursuit in litigation for plaintiff landlords. The clause should also apply only to significant or material breaches, like nonpayment of rent. If it appears the clause is triggered by minor breaches, the acceleration clause may be deemed unenforceable. Finally, a prudent landlord would take care to draft an acceleration clause that bears a reasonable relation to the actual damages that the landlord would incur in the event a tenant breached the lease, factoring reasonable potential mitigation. A landlord could do this by ensuring that the lease requires the landlord to mitigate damages (which may be statutorily required anyway), and the landlord actually does take reasonable steps to mitigate damages and is prepared to offer well-documented evidence of its mitigation efforts as necessary in litigation.
Does a Lease Require an Acceleration Clause?
In many jurisdictions, acceleration of rent may not be an automatic remedy for the landlord unless provided for in the lease. Thus, landlords may want lease default remedy terms that include an acceleration clause that is as explicit and detailed as possible with an unequivocal statement that the lease holds the tenant responsible for all after accrued rents.
Acceleration clauses should specifically reference a landlord’s entitlement to unaccrued, or future, rents. For example, a commercial lease provision that included a broadly worded damages clause—allowing a landlord to recover from a defaulting tenant “damages for its breach”—was not sufficient to entitle a landlord to recover accelerated or future rents. TSI, Inc. v. Am. Gem Corp., No. 02-253, 2003 WL 22469832, at *1 (Mont. Oct. 30, 2003). Further, to the extent a landlord is attempting to recover other future damages, it should expressly reference any operating costs, insurance costs, or taxes it also expects to recover. In the absence of clear language expressly preserving the right to unaccrued rents, the tenant may not remain liable for unaccrued rents.
In some jurisdictions, however, a lease that lacks an acceleration clause may benefit from common-law rights. In Austin Hill Country Realty, Inc. v. Palisades Plaza, Inc., 948 S.W.2d 293 (Tex. 1997), the Texas Supreme Court found that Texas courts have traditionally provided four causes of action for a tenant’s breach and abandonment. Among these causes of action is a landlord’s right to treat the tenant’s breach as an anticipatory repudiation, which allows the landlord to repossess the premises and sue for the present value of future rentals reduced by the reasonable cash market value of the property for the remainder of the lease term.
What Damages Are Available to a Landlord under an Acceleration Clause?
Theoretically, an enforceable acceleration clause allows a landlord to recover a lump sum of the payments due under the full remaining term of a breached lease. However, many courts apply a formula that requires a landlord to reduce the future rental value to present value and to further reduce that amount by the cash market value of the premises. The two key terms in this calculation are not always clearly defined or applied under the law. First, what is the discount rate? Second, what is the cash market value?
Discount rate. A discount rate is a percentage rate, often provided by the lease and a potentially negotiated term, that indicates the amount by which future rent will be reduced to present value. A discount rate is effectively the interest rate that is used to determine the present value of future rent and, hence, cash flow under the lease. The trouble comes in when the lease itself does not specify a discount rate. Where a discount rate is not contractually agreed to and defined by the lease, the appropriate discount rate may be a litigated point in a suit for future rent damages and could thwart a landlord’s plans for a quick summary judgment. Providing for an agreed-upon discount rate in the lease may serve to ease some bumps on the litigation road.
Fair rental value or cash market value. After applying the discount rate, courts further reduce the present value of the accelerated lease by the fair rental value or the cash market value of the premises. This raises yet another question about how to calculate accelerated rent. Does a landlord reduce the accelerated amount by the market value of the premises or does the landlord recover on the market value of the lease? This topic was astutely addressed by the Texas Court of Appeals addressing the meaning of “cash market value” in GKG.Net, Inc. d/b/a Global Knowledge Group v. Mitchell Rudder Properties, L.P., 330 S.W.3d 426, 432–33 (Tex. App. Houston [14th Dist.] 2010, no petition). The GKG court determined that this portion of the formula must apply to the cash market value of the premises for the remainder of the lease term. If the landlord calculated the cash market value of the lease, the amount would always be zero because the lease no longer holds value after a tenant’s breach and abandonment of the premises. This, however, may create more questions. Is a landlord required to calculate the cash market value for the lease at the time of the breach or throughout the term of the lease, which could last up to 20 years? These types of issues may provide interesting areas for potential expert opinion regarding market conditions and, if controverted, may ultimately thwart that speedy summary judgment—good for defaulting tenants, bad for plaintiff landlords.
Regardless, the ultimate goal in reducing the full accelerated amount due by the present value and cash market value is to award the landlord damages that bear a reasonable relation to the actual damages the landlord incurs as a result of the breach.
Finally, the landlord should make efforts to show that it took reasonable steps to mitigate its damages. In the event the landlord attempted to mitigate damages or could not locate a replacement tenant, the landlord may be awarded the full amount of its damages.
Evidence in Support of the Damages Clause
One interesting Texas memorandum opinion addresses the competency of an affidavit used in support of an acceleration clause. In CamargoCopeland Architects, L.L.P. v. CRT Signature Place, L.P., No. 06-13-00079-CV, 2013 WL 6535947 (Tex. App. Dallas Nov. 18, 2013) (mem. op., not designated for publication), a commercial landlord filed suit against a tenant for the remaining balance of the lease in the amount of $515,059.68. The lease provision provided for accelerated rent, discounted to present value. The tenant challenged the competency of the affidavit, arguing that it lacked a mathematical breakdown of the damages.
The appellate court affirmed the trial court’s summary judgment in favor of the landlord, finding that the affidavit was competent because it specified the amount of rent past due, referenced the monthly rent payment schedule, provided that the total damages were calculated using the lease provisions, and included the applicable rate of interest. According to the CamargoCopeland opinion, a damages calculation that follows the language of an enforceable acceleration clause and properly discounts the amount to present value may be considered competent evidence in support of a motion for summary judgment.
What Defenses Can a Tenant Rely On?
To contest the enforcement of an acceleration clause, a tenant may consider asserting the following defenses:
The lease clause is unenforceable as a penalty.A defaulting tenant could assert that the accelerated rent was not properly discounted to present value. Depending on the jurisdiction, the tenant may also assert that the acceleration clause failed to assess the future market rental value of the premises and the probability of re-letting the premises.
Unconscionable forfeiture. In pursuing this defense, which is similar to the unenforceable penalty defense, a tenant may argue that the acceleration clause was unconscionable given the bargaining disparity between the parties.This point was addressed by the court in Cummings Properties, LLC, in which the court relied on the key fact that the negotiating parties were both sophisticated commercial entities. A tenant should also consider arguing that the landlord failed to properly mitigate damages and retained possession of the premises. As a result, the tenant could argue that the acceleration clause results in an unconscionable windfall in favor of the landlord.
Mitigation of damages. A defaulting tenant should always plead mitigation of damages as an affirmative defense. A tenant should review the applicable jurisdiction’s requirements on pleading this defense, as at least one state requires that a tenant prove that the landlord failed to mitigate and the amount that could have been saved had the landlord properly mitigated. Cole Chem. & Distrib. Inc. v. Gowing, 228 S.W.3d 684 (Tex. App. Houston [14th Dist.] 2005, no petition). Further, failure to plead this affirmative defense may bar a defaulting tenant from asserting on appeal that the landlord’s conduct in failing to perform its statutory duty to mitigate was inequitable and unconscionable and resulted in a windfall to the landlord. Cummings Props., LLC, 869 N.E.2d at 622–23.
There is a variety of opinions on how accelerated rent clauses should be handled. The potential fact and legal issues that may crop up in litigation of acceleration clauses make them a challenge for summary judgment and trial. Litigators representing landlords have an opportunity to use enforceable accelerated rent clauses as powerful leveraging tools in litigation; however, they may have to bring their landlord clients back to reality by highlighting the potential problems with enforceability or controvertible future rent damages. Litigators representing tenants should push hard on enforceability and dig into weak or unsupportable future rent damage calculations.
Keywords: real estate litigation, lease, acceleration clause, damages, rent
Copyright © 2017, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).