THE OLDEST LAW JOURNAL IN THE UNITED STATES Court Ruling in Genuardi’s Case Multiplies Lease Damages By Martin J. Doyle and Igor Pleskov

As originally published in The Legal Intelligencer, February 2, 2015

On Aug. 19, 2014, the Superior Court of Pennsylvania reached a decision as to the proper measure of damages for a tenant’s breach of a shopping center lease. The court’s decision has important implications for practitioners negotiating damages clauses, in particular when drafting language imposing a duty to mitigate or discounting lost rent damages to present value.

Newman Development Group of Pottstown LLC (the landlord) sued Genuardi’s Family Market Inc. and Safeway Inc. (the tenant) for an anticipatory breach of a lease for property in Chester County, Pa.’s Town Square Plaza. The parties had entered into a 20-year lease in April 2000, but the lease included specific deadlines for building permits that proved impractical in light of opposition to the project, according to the opinion in Newman Devel- opment Group of Pottstown v. Genuardi’s Family Market, No. 744 EDA 2010 (decided Aug. 19, 2014). Conse- quently, the parties agreed to hold the lease in escrow pursuant to an escrow agreement that gave each party the right to terminate the lease if the landlord was unable to fulfill a co-tenancy condition requiring a sale or lease to Target or Lowe’s within one year from the date landlord acquired the property. The landlord had yet to acquire the property, as its purchase was conditioned on certain approvals and rezoning of the property.

Shortly thereafter, in December 2000, Genuardi’s Family Market assigned the lease to Safeway. Safeway con- tinued to negotiate with the landlord and discuss the project, with the understanding that final approvals for the development would likely not occur until March 2002. Nonetheless, on Feb. 13, 2002, Safeway informed the landlord that it was terminating the lease pursuant to provisions contained in the escrowed lease permitting the tenant to terminate in the event the landlord fails to obtain building permits by a certain date (long since passed). The landlord refused to accept the termination, arguing that the escrow agreement superseded the lease and that the tenant had no right to terminate under the terms of the lease, as modified presently. The landlord then pro- ceeded to sue the tenant for an anticipatory breach of the lease.

In the meantime, the landlord split the space to be leased to the tenant into two separate spaces and entered into leases with PetSmart and Michaels for those spaces. The term for each of the new leases was 10 years with two five-year renewal options.

The trial court (and each subsequent court on appeal) held that the escrow agreement in this case did serve to amend the lease, insofar as the escrow afforded the landlord additional time to satisfy its conditions for delivery. Consequently, the tenant was held to have breached the lease when it sought to terminate.

The trial court initially awarded the landlord damages in the amount of $131,277, based on the amount of rent that the tenant would have paid under the lease for the six-month period between the earliest date rent would be

- 1 - due and the date the landlord sold the property (a period of less than one year), less the amount actually paid by PetSmart and Michaels during that same time period. The trial court made this calculation instead of relying upon the calculation based on the lease’s damages provision (which provided that damages would equal all rent for the balance of the term), holding that the damages provision in the lease was an unenforceable liquidated damages provision.

The Superior Court, however, disagreed. The Superior Court held that the damages provision in the leases— which called for payment of all rent that would have accrued during the entire term, less any mitigating rents received—was enforceable, and awarded the landlord damages totaling in excess of $18 million. This, even in light of a contractual duty on the part of the landlord to mitigate its damages.

Eventually, the case made its way before a three-judge panel of the Superior Court, and then the Superior Court en banc. Among other issues, the Superior Court reviewed whether the damages from lost rents should have been reduced to present value and whether the trial court properly reduced the award in light of the landlord’s duty to mitigate.

Reduction to Present Value Notwithstanding the lack of language in the lease requiring a reduction to present value, the tenant argued that the lost-rents portion of the damage award should be reduced to present value as a matter of law. Given the 20-year term of the lease, this would have been a material reduction. The Superior Court disagreed and held that Penn- sylvania law requires no such reduction. The landlord and tenant were two sophisticated parties that could have negotiated a reduction to present value if they so desired (as the landlord did in its lease with PetSmart). The court relied on contract law principles to uphold the parties’ intent rather than imposing a reduction by matter of law.

Duty to Mitigate The tenant also argued that the trial court insufficiently reduced the rental loss damages in light of the landlord’s contractual duty to mitigate (the lease required the landlord to “endeavor in good faith to mitigate any damages for which tenant might be liable”), when evaluating the impact of the landlord’s substitute leases with Michaels and PetSmart. The original lease between the landlord and tenant was for 20 years, while the lease term for the substitute tenants was for 10 years, each with two five-year renewals. The landlord persuaded the court that it was unable to find another “20-year tenant.” In calculating the damage award, then, the trial court awarded rental damages for the entire 20-year term less the amount the landlord was to receive over only the 10-year initial terms of the substitute leases. The trial court did not include the renewal terms nor did they adjust the award for any rentals that the landlord could potentially receive in years 11 through 20.

The Superior Court upheld the calculation, reasoning that any reduction for rents beyond the 10-year lease term was speculative and unreliable. The court decided that it could not adequately determine whether the replacement tenants would exercise their renewal option or if the landlord would be able to obtain new tenants in the event that the replacement tenants did not exercise the renewal options. The lack of reasonable certainty led the court to discount as irrelevant any potential rents beyond those to be paid during the original lease term of the substitute tenants.

- 2 - Practice Tips One clear takeaway from the Superior Court’s decision is the importance of including a reduction to present value when negotiating damage provisions that allow the aggrieved party to recover payments it would have otherwise received in the future. Such a reduction is a reasonable negotiation point and appropriate from a “rightful posi- tion” analysis. Otherwise, the wronged party receives a windfall in the amount of the time value of money that it receives as a lump sum, rather than the negotiated rental streams set forth in the lease.

Since there is no common-law duty to mitigate in Pennsylvania, imposing a contractual duty on the landlord is always considered a victory for the tenant. Nonetheless, the Superior Court’s unexpected decision highlights the limitations and potential issues with a simple requirement to mitigate, in particular when the landlord has the right to accelerate rent for the entire term, and especially if the tenant has obligations that other tenants are unlikely to undertake (consequently, arguably, “unmitigatable”). The court in this case accepted that the landlord could not, at this time, mitigate the loss of latter years’ rentals, and then enforced the acceleration of all rent with- out any credit whatsoever for those latter years. Presumably this will result in a windfall for the landlord in years 11 to 20 (unless the landlord is then required to reimburse the tenant for any rents collected). The ideal solution for similarly situated tenants is likely to be a damages calculation that reduces the rental damage award by the reasonable fair market rental value of the leased premises. This too is not an easy sell with landlords, but may be worth raising, if circumstances justify, and the tenant has the clout to demand it.

Martin J. Doyle is a partner in Saul Ewing’s real estate department focusing on all aspects of transactional real estate law. Doyle can be contacted at [email protected]. Igor Pleskov is an associate in the firm’s real estate department focusing on all aspects of transactional real estate law. Pleskov can be contacted at ipleskov@saul. com.

This article is reprinted with permission from the February 2, 2015 issue of The Legal Intelligencer. (c) 2015 ALM Properties Inc. Further duplication without permission is prohibited. All rights reserved.

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