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Is that Waiver of Mitigation that has Suddenly Appeared in that New Commercial Real Estate Lease Enforceable?

The obligation to mitigate damages for the breach of a contract is a staple of hornbook law. This obligation is so ingrained in our system of jurisprudence that most jurisdictions have refused to enforce contractual waivers of the obligation to mitigate damages. Recent cases in North Carolina and Ohio, though, indicate that there may be a crack developing in the floodwall that has kept such waivers from flowing into the highways of commerce.
Under the common law, a landlord was not required to mitigate its damages if a tenant breached the lease agreement. Although the Restatement (Second) of Property (Landlord & Tenant) § 12.1(3) (1977) still follows the traditional rule and states that "Except to the extent the parties to the lease validly agree otherwise, if the tenant abandons the leased property, the landlord is under no duty to attempt to relet the leased property for the balance of the term of the lease to mitigate the tenant's liability under the lease, including his liability for rent….”, the modern trend is to require the landlord to mitigate damages, especially in residential lease situations. Only a half-dozen or so states still permit a landlord to decline to mitigate damages after a breach. Although somewhat dated, the case of Austin Hill Country Realty v. Palisades Plaza, 948 S.W.2d 293 (Tex. 1997) provides an excellent survey of this area of the law.
The North Carolina Court of Appeals has twice now ruled that waivers of a landlord’s obligation to mitigate damages after a breach can be enforced in commercial real estate leases in that state. Initially, in Sylva Shops, Ltd. P'ship v. Hibbard, 623 S.E.2d 785 (N.C. Ct. App. 2006), the court of appeals held that such a waiver was not contrary to law or public policy. The court noted that although waivers were often found to be unenforceable because of the inequality of bargaining power between the landlord and the tenant, this factor was not present in the lease before it. “Defendants have not argued that the clause was obtained through an inequality of bargaining power. The lease represents an arm's length commercial transaction with both parties using brokers or advisors to assist them in obtaining the best possible bargain.”
The court was of the view that inequality of bargaining power was generally not a factor in commercial settings. “In examining commercial real estate lease transactions in light of public policy considerations, we recognize that negotiations generally involve relatively equal bargaining power due to the availability of other space and the fact that neither party is compelled to make a deal. Each lessee has to determine whether the lease offered is acceptable in business terms.” The court went on to note that some states, such as Illinois and Texas, had legislatively prohibited such waivers, but that the North Carolina General Assembly had not done so.
The following year, the same court again found that a commercial landlord was not required to mitigate its damages, although the ruling was more specifically focused on the peculiarities of the lease and the facts. In Kotis Props., Inc. v. Casey's, Inc., 645 S.E.2d 138 (N.C. Ct. App. 2007), the court of appeals rejected the argument of the tenant’s assignee that the landlord had failed to mitigate its damages after the breach of a restaurant lease. The court found that the lease waived the landlord's duty to mitigate only if the landlord reentered the premises without termination of the lease, and conversely if the landlord terminated the lease, then the waiver was not effective. The court found that the record did not contain any notice specifying that there was a termination of the lease, and because the landlord's taking of possession of the premises did not, standing alone, amount to an election to terminate, the assignee failed to prove that the waiver was not applicable. While the court did not speak to the public policy of enforcing such waivers, it did state that it was following the rule that it had set forth a year earlier in Sylva Shops.
Ohio seems to have arrived at a similar rule, although the road to that rule is not as clear. The Ohio Supreme Court in 2003 ruled in Frenchtown Square P'ship v. Lemstone, Inc., 99 Ohio St. 3d 254 (2003), that a landlord had a duty to mitigate damages after the breach of a commercial lease. In a statement that sounds very tenant friendly, the court stated that “The duty to mitigate arises in all commercial leases of real property, just as it exists in all other contracts….Landlords owe a duty to mitigate their damages caused by a breaching tenant. That rule flows from the premise that modern leases are more than simply property-interest transfers; rather, leases possess contractual qualities that often include myriad covenants and duties and arise from a bargained-for relationship.” But the court modified that rule when it said that “In a practical sense, lessors and lessees contract for the use of property. Accordingly, barring contrary contract provisions, a duty to mitigate damages applies to all leases.” (emphasis added)
Three years later, the court of appeals in Cleveland upheld a mitigation of damages waiver in Parkway Bus. Plaza Ltd. P'ship v. Custom Zone, Inc., 2006 Ohio 5255 (Ohio Ct. App., Cuyahoga County), ruling that a guarantor of a commercial lease had validly waived its right to assert certain affirmative defenses, including mitigation of damages. The guarantor had agreed to waive “the right to interpose all substantive and procedural defenses of the law of guaranty, indemnification, and suretyship, …the right to interpose any defense (except as allowed under (ii) above), set-off, or counterclaim of any nature or description in any action or proceeding.” The agreement did not specifically speak to a waiver of the obligation to mitigate damages, but the court concluded that it was a defense that had been waived.
Interestingly, neither Ohio court mentioned an earlier Ohio case that had specifically upheld such waivers, nor was that earlier decision in New Towne Ltd. Pshp. v. Pier 1 Imports, 113 Ohio App. 3d 104 (Ohio Ct. App., Lucas County 1996), cited in the appellate briefs in Parkway Bus. Plaza. The court of appeals in New Towne had stated that “Accordingly, we hold that under principles of contract law, a commercial landlord has the duty to mitigate damages. Consequently, absent provisions negating this requirement, appellee had a duty to mitigate damages once appellant abandoned the premises….In this case, the lease contains a provision which specifically annuls any duty to mitigate. Parties of equal bargaining power are free to enter into any agreement the terms of which are enforceable at law.”
The New Towne court specifically found that the waiver did not violate public policy. “In the present matter, the term negating any duty to mitigate damages contained in the lease does not violate any principle of law. Similarly, it does not injure the welfare of the public in any way. As a result, the provision does not violate public policy.” Interesting, although neither of the later Ohio decisions mentioned New Towne, the North Carolina court specifically referred it in Sylva Shops.
Attorneys who draft leases for commercial real estate clients, unless they are in a State, such as Texas or California, that specifically prohibit such waivers by legislation, should determine if a reasonable argument for such a waiver can be made in their jurisdiction. Conversely, attorneys who represent commercial tenants should be prepared to advise their clients on the potential viability of such waivers in their jurisdiction. In the present commercial real estate market, landlords will be seeking any advantage they can to limit their losses.
[Editor's Note: Readers with a subscription to and the Matthew Bender publications can quickly and accurately research the law relating to the mitigation of damages in commercial real estate leases in 1-4 Commercial Damages: Remedies in Business Litig P 4.03 and 2-31 Commercial Damages: Remedies in Business Litig P 31.04.]