February 28, 2021 Articles

Early Lease Terminations: The Duty to Mitigate Damages and the Role of the Expert Witness

What obligation does a commercial landlord have?

By C. Knox Withers and Georgina C. Shepard
As the pandemic ravages the economic landscape, businesses continue to fail at a high rate.

As the pandemic ravages the economic landscape, businesses continue to fail at a high rate.

Credit: Kanawa_Studio, iStock

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Although COVID-19 rages on, most commercial tenants’ reliance on force majeure, impossibility, and frustration defenses have played out, and the fight over early terminations now focuses on the more historically familiar issue of mitigation of damages. Perhaps more than ever, these questions are key for both landlords and tenants: Upon a tenant’s abandonment of its leased premises, what obligation does a commercial landlord have to mitigate its damages? And how can a landlord carry its burden of proof on that issue in the event of litigation?

As the coronavirus continues to ravage the economic landscape, businesses continue to fail at an unprecedented rate. Many landlords have already sued tenants for unpaid rent on vacated premises, and more litigation will inevitably follow. Most tenants have found force majeure clauses, as well as common-law impossibility and frustration arguments, unhelpful in absolving them of the obligation to pay rent or continue operating (or both). Many still had to cease operations with lease term remaining. These tenants’ best bet is to advance arguments designed to minimize their exposure, which typically place the efforts to which a landlord has endeavored to mitigate its damages squarely in issue. To effectively litigate mitigation on behalf of a landlord or tenant, it is critical to understand (a) the extent to which a landlord has any common-law, statutory, or contractual duty to mitigate its damages; (b) the efforts necessary to satisfy the duty to mitigate; and (c) how expert witness testimony factors into carrying that burden in court.

A Landlord’s Duty to Mitigate

For the purposes of this article, we will assume that a commercial landlord has a duty to mitigate its damages following a tenant’s abandonment of the premises. Traditionally, that was not always the case. For many years, courts viewed leases as conveying an interest in land, and, in that view, having parted with possession, a landlord had no duty to mitigate its damages. See Reid v. Mut. of Omaha Ins. Co., 776 P.2d 896, 905 (Utah 1989) (discussing the history of the common-law rule). A number of jurisdictions still follow the traditional rule. See, e.g., Shaheen & Co. v. Dickson, 427 S.E.2d 825, 826 (Ga. Ct. App. 1993) (“[U]nlike some jurisdictions, Georgia does not require mitigation of damages in lease contracts.”). The modern rule, however, regards leases as creatures of contract law. Consequently, as with respect to other types of contracts, a non-breaching landlord has a duty to mitigate its damages following a tenant’s default. See, e.g., Leavenworth Plaza Assocs., L.P. v. L.A.G. Enters., 16 P.3d 314, 317 (Kan. Ct. App. 2000).

Separately, regardless of the rule adopted in a given jurisdiction, commercial leases frequently include provisions that impose on the landlord a duty of mitigation. See, e.g., MBC, Inc. v. Space Ctr. Minn., Inc., 532 N.E.2d 255, 261 (Ill. App. Ct. 1988) (finding that the landlord was under a duty to mitigate damages where the lease provided for the lessor to use reasonable efforts to relet the premises). It is worth noting that the same principle of freedom of contract can nevertheless allow parties to negotiate around the duty to mitigate damages in certain jurisdictions that follow the modern rule. See, e.g., Sylva Shops LP v. Hibbard, 623 S.E.2d 785, 790 (N.C. Ct. App. 2006) (“[W]e can perceive no basis for precluding a party from contracting to relieve itself from a duty of care to minimize its damages.”). Conversely, other modern-rule jurisdictions have elected to invalidate such contractual provisions on the theory that they violate public policy. See, e.g., Tex. Prop. Code § 91.006(b) (“A provision of a lease that purports to waive a right or to exempt a landlord from a liability or duty [to mitigate damages if a tenant abandons the leased premises in violation of the lease] is void.”).

Where a landlord bears the burden to mitigate its damages—whether as a matter of statute, common law, or contract—the first question becomes the following: What is the extent of the landlord’s duty of mitigation? Typically, a commercial landlord must employ reasonable efforts to find a replacement tenant or otherwise derive economic value from the abandoned premises. See, e.g., Leavenworth Plaza Assocs., L.P., 16 P.3d at 317 (“The duty to mitigate damages is not an unlimited one and an injured party is required only to exert reasonable efforts to prevent or minimize his damages within the bounds of common sense.”). Courts may also refer to the obligation by other monikers, including good-faith efforts, objectively reasonable efforts, commercially reasonable efforts, and reasonable diligence. See, e.g., Austin Hill Country Realty, Inc. v. Palisades Plaza, Inc., 948 S.W.2d 293, 299 (Tex. 1997) (“objectively reasonable efforts”); Reid, 776 P.2d at 906 (“commercial reasonableness”); Ruud v. Larson, 392 N.W.2d 62, 63 (N.D. 1986) (“good faith efforts”)Finish Line, Inc. v. Jakobitz, 557 N.W.2d 914, 915 (Iowa Ct. App. 1996) (“reasonable diligence”).

“Reasonable” Efforts and the Role of the Expert Witness

An expert witness will prove helpful—if not essential—in proving whether the landlord has made sufficient efforts to minimize its damages following a tenant’s default. The standard for reasonable efforts to mitigate is objective, but it is far from a bright-line test. Rather, it presents a question of fact, and courts may consider all facts and circumstances of the particular case in order to make this determination. While jurisdictions vary on the issue of which party bears the burden of proof when it comes to mitigation, both parties will need expert testimony to educate the fact finder on the local market, likely time to relet, and the rental value of the premises.

The inquiry starts with a landlord’s affirmative steps to find a new tenant, but the analysis does not occur in a vacuum. The trier of fact will weigh those efforts against numerous factors, including the particular terms of the lease, the nature of the property, and the relative strength of the local real estate market. A proper expert witness (usually a leasing broker intimately familiar with the local market) can provide valuable insight and testify to factors such as the overall community economic depression, a decline or rise in a particular industry relevant to commercial space, or fluctuations in competition for retail space in a region.

Although the body of national case law illustrates how fact-intensive this inquiry is, there are a number of common elements that arise when a tenant abandons a commercial property and a landlord must mitigate its damages. These include the need to advertise, the engagement of a broker or agent, the failure to relet to a prospective new tenant, the reletting at a higher (or lower) rent, and the election to repair (or failure to maintain) the premises following the tenant’s abandonment.

Basic Efforts

Generally, a landlord must, at a minimum, advertise the premises for rent (either with a sign at the site or in a local publication or multiple listing service (MLS) or both), show the premises to prospective tenants, and engage a broker. J.M. Grimstad, Inc. v. Scangraphics, Inc., 539 N.W.2d 732, 735 (Iowa Ct. App. 1995) (stating that circumstances required lessor “to do something more than sit by passively and not take an active role” in attempting to enlist prospective lessee). Certain courts have identified these basic requirements as a minimum threshold for establishing reasonable efforts. See, e.g., Pomeranz v. McDonald’s Corp., 821 P.2d 843, 847 (Colo. Ct. App. 1991), aff’d in pertinent part, rev’d in part, 843 P.2d 1378 (Colo. 1993) (commercial landlord failed to mitigate damages arising from tenant’s breach of lease, where, despite poor rental market for commercial real estate in area at time, landlord did not place ad in newspaper, list property with real estate agent, or place sign on property). It is critical to note, however, that doing the bare minimum does not necessarily meet the reasonableness standard in every case. See J.M. Grimstad, Inc., 539 N.W.2d at 735 (“Reasonable diligence may require more out of a landlord in some situations than in others.”).

There can be circumstances in which failing to meet one of these basic requirements does not, standing alone, render the landlord’s efforts unreasonable. Indeed, the specific market conditions existing at the time of the tenant’s breach can significantly hinder the landlord’s ability to secure a replacement tenant—so much so that the relative economic health of a locale can even erode the basic requirements of advertising and the use of a broker. See, e.g., Brendle’s Stores, Inc. v. OTR on Behalf of Bd. of Trs. of State Teachers Ret. Sys. of Ohio, 978 F.2d 150, 158 (4th Cir. 1992) (finding that landlord’s lack of action did not discourage any prospective tenants and that evidence shows that extensive advertising would not have resulted in a new tenant). The proper expert will be equipped to testify regarding local market conditions. Moreover, the duty to mitigate does not impose an obligation to make efforts that exceed the landlord’s typical actions with respect to the letting of its other spaces. In other words, there is no duty to treat an abandoned premises better than other spaces. See, e.g., MXL Indus., Inc. v. Mulder, 623 N.E.2d 369, 378 (Ill. App. Ct. 1993).

Advanced Undertakings

Some courts have observed that a landlord’s duty to mitigate can include an obligation to make repairs necessary to actively market premises for rent. See, e.g., Montgomery v. Sollberger, 94 N.E.3d 24, 27 (Ohio Ct. App. 2017); Borough of Fort Lee v. Banque Nat’l de Paris, 710 A.2d 1, 7 (N.J. Super. Ct. App. Div. 1998). However, a landlord may not be required to restore a property to marketable condition as a prerequisite to mitigation when the tenant left the premises in poor condition. See, e.g., Tripps Rests. of N.C., Inc. v. Showtime Enters., Inc., 595 S.E.2d 765, 768 (N.C. Ct. App. 2004) (observing that “plaintiff presented evidence that defendants left the property in such poor condition that it would have cost several hundred thousand dollars just to restore it to a condition in which it could be rented”). Similarly, mitigation does not entitle an abandoning tenant to a reduction of damages in the amount of any unpaid tenant allowance provided under the lease. See, e.g., Tech Ctr. 2000, LLC v. Zrii, LLC, 363 P.3d 566, 572 (Utah Ct. App. 2015).

Signing a New Lease

The question of the landlord’s efforts extends to whether it does, in fact, sign a new lease once a prospective tenant is found. Litigants may want an expert to offer testimony regarding the appropriate uses of the premises, the qualifications of proposed replacement tenants, and similar issues. For example, the duty to mitigate does not require a landlord to accept any and all replacement tenants. See, e.g., Conn. Gen. Life Ins. Co. v. Melville Realty Co., Inc., 591 So. 2d 1376, 1378 (La. Ct. App. 1991) (lessor’s efforts to relet were reasonable despite ultimate failure to relet premises, where lessor found prospective tenant at time when market was very soft and failed to relet premises to tenant due to lease guarantor’s reservation of right to object to proposed rental terms). Likewise, a landlord may reject a replacement lessee that cannot demonstrate reasonable creditworthiness or where the proposed new use of the premises violates existing exclusives or is otherwise incompatible with a current tenant mix. See, e.g., Austin Hill Country Realty, Inc., 948 S.W.2d at 299 (a landlord’s duty to make reasonable efforts to mitigate does not require that the landlord accept replacement tenants who are financial risks or whose business was precluded by the original lease). Further, it may be unreasonable to require a landlord to provide significant tenant allowance funds in order to secure a replacement tenant.

Expert witnesses can also testify regarding the reasonableness of the rental rate the landlord seeks from a replacement tenant. Because economic conditions at the time of the tenant’s breach may be vastly different from those that existed at the inception of the lease, the expert should be familiar with what constitutes a reasonable rent at the time of mitigation. For example, a landlord may be deemed to have failed to mitigate if it rejects an acceptable replacement in the hope that a more economically favorable tenant comes along. In this regard, some courts have found that requiring reasonable efforts to mitigate by a landlord does not impose the financial risk of certain business decisions or strategies on the abandoning tenant. See, e.g., O’Brien v. Black, 648 A.2d 1374, 1378 (Vt. 1994) (landlord could not charge the abandoning tenant with the risk and cost of its decision to refuse to entertain a prospective tenant in order to pursue a more lucrative tenant).

On the other hand, some courts have ruled that the fact that an abandoned property was leased—or offered—at a higher rent than the one charged in the original lease did not result in a failure to mitigate damages. See, e.g., Del E. Webb Realty & Mgmt. Co. of Colo. v. Wessbecker, 628 P.2d 114, 116 (Colo. Ct. App. 1980). A determinative factor in reaching this conclusion is often whether the new, higher rate sought is consistent with the comparable market rate. In such a case, an expert witness’s testimony is the most effective way to present this evidence.

Conclusion

Even in the absence of a common-law, statutory, or contractual duty to mitigate damages, reasonable landlords will almost always be well served to relet a vacant premises following a tenant’s abandonment. But where the landlord has an affirmative duty to mitigate, a key issue in any later litigation may be whether it has carried that burden. To address that question, expert testimony regarding the reasonableness of the landlord’s efforts can be critical. The analysis concerns not only whether the landlord took appropriate steps to market the space to prospective tenants; the inquiry also entails questions regarding the reasonableness of the rental rate demanded, the necessity of repairing the premises, the qualification of a replacement tenant, and the use to which a new tenant will put the space, among others. These factors are neither uniform nor static. The prudent use of an expert witness familiar with the local market and economic climate may make the difference in proving the extent to which a landlord has undertaken reasonable efforts to mitigate its damages.

C. Knox Withers and Georgina C. Shepard are with Arnall Golden Gregory LLP in Atlanta, Georgia.


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