Commercial Tenant Can’t Share in Shopping Mall Condemnation Award

strip-mallIn Village of Palatine v. Palatine Associates, LLC, 2012 IL App (1st)  102707, an eminent domain (condemnation) suit, the defendant owned a shopping center and was a lessor on several commercial leases – all of which contained provisions that said in the event of condemnation proceedings, the tenant would share in any award.  The plaintiff Village filed a condemnation suit about two years into a ten-year lease between the defendant landlord and a commercial tenant.  The condemnation suit eventually settled with the landlord getting nearly $5M in proceeds to the exclusion of the tenant.  Tenant appealed.

Held: Affirmed:

Basis: The First District agreed with the trial court that the landlord terminated the tenant’s lease before the condemnation award.  The Court rejected tenant’s argument that the landlord’s 5-day notice was deficient and that the landlord waived the notice by accepting partial payment.  In Illinois, acceptance of rent in a commercial lease setting is not a waiver if the notice explicitly gives the landlord the right to accept partial payment. Palatine Associates, ¶¶ 73-75. 

The Court also discarded the tenant’s fraud in the inducement defense.  The Court enforced the lease’s “non-reliance” clause, through which the tenant certified that it wasn’t induced to enter the Lease by any landlord representations.  Id., ¶ 79.  The non-reliance clause precluded the, tenant from establishing justifiable reliance – a required fraud in the inducement element.  The court also rejected tenant’s claim that the non-reliance clause was an unenforceable exculpatory clause that immunized the landlord for wilful and wanton conduct.  The reason: the lease text said nothing about insulating the landlord from intentional torts.  (¶¶ 82-83).

Conclusion

Palatine Associates provides a good summary of Illinois contract formation, interpretation and enforcement rules in the commercial lease context.  Though its  serpentine procedural history is hard to follow, the general rules gleaned from the case are simple.  For lessors, the case reaffirms the importance of both 5-day notices and that a lease specifically state that only full payment will waive a lease default.  The case also shows that in commercial lease context, integration and non-reliance clauses are enforceable against tenant defenses based on pre-lease representations by a landlord.

For tenants, the case cautions to be leery of lease terms that allow landlords to accept partial payments without waiving the default as well as lease integration and non-reliance clauses.  An integration clause will bar any evidence of a landlord’s oral representations that conflict with the written lease.  A non-reliance provision will preclude a fraud in the inducement claim.   

The Ubiquitous “Excess Rent” Provision

The boilerplate “excess rent” or “rent differential” clause appears in many commercial leases.  Usually buried in a voluminous lease, no one pays much attention to it until the tenant vacates and the landlord sues for damages.  All of a sudden, the excess rent clause assumes critical importance as the landlord tries to prove up its damages.  The rent differential/excess rent section generally provides that when a tenant prematurely vacates commercial property, the landlord can recover the difference between (A) the present value of lease rent owed through the unexpired lease term and (B) the fair market rent for the unexpired term (rent through the balance of lease at lease rate minus market value of rent through lease expiration).  St. George Chicago, Inc. v. George J. Murges & Associates, Ltd., 296 Ill.App.3d 285 (1st Dist. 1998).  In Illinois, these rent differential terms are enforceable and will satisfy the lessor’s statutory duty to mitigate set forth in Section 9-213.1 of the eviction statute.

So if the breaching tenant was paying $1,000 a month under its lease, and the landlord can only find a replacement tenant who pays $600/month – the landlord can recover $400/month ($1,000 minus $600) times the numer of months left on the defaulting tenant’s lease.  Of course, if the market value is now $1,500/month – $500 more than the lease amount – the landlord cannot recover anything.  Instead, the landlord’s recovery will be limited to its damages incurred through the date the replacement tenant begins paying rent.

The Landlord’s Duty to Mitigate Damages

 

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When a commercial tenant defaults under a multi-year lease, say by abandoning the premises with several years left on the lease, the law requires the landlord to mitigate its damages.  So, if retail tenant skips out on a 10-year lease after year 2,  the landlord cannot sit idly by for 8 years and then recover 8 years’ worth of rent damages from the tenant.  Instead, the landlord must make measurable efforts to try to relet the property and reduce its monetary loss.

Section 9-213.1 of the Illinois eviction statute codifies the landlord’s duty to mitigate: “a landlord or his or her agent shall take reasonable measures to mitigate the damages recoverable against a defaulting lessee.” 735 ILCS 5/9-213.1.

Whether a landlord has met its duty to mitigate damages is a fact question for the judge or jury.  If a landlord tries to relet commercial property at a higher rate than was being paid by the breaching tenant, it might raise a red flag and result in a failure to mitigate.

What steps should a landlord take then when a tenant to breaches a multi-year lease?  There is no litmus test but Illinois state and Federal courts do provide some guidance.

One Illinois court found that the landlord mitigated its damages when it (1) engaged a building manager to market the site; (2) erected signage on the premises; (3) placed calls to real estate brokers and developers; (4) ran newspaper ads; and (5) offered trial witness testimony that placing advertisements and erecting signs constitute reasonable steps toward reletting the premises. MXL Industries, Inc. v. Mulder, 252 Ill.App.3d 18 (2d Dist. 1993).  (Note: now, in the computer age, a landlord should also list the property on Costar, Loopnet or similar sites.)

By contrast, the Seventh Circuit Appeals Court found a failure to mitigate where the suing landlord (1) waited five months to hire a broker to relet the property; (2) refused to improve the property; (3) attempted to re-rent the premises at a higher rental rate (than the defaulting tenant paid); and (4) didn’t rent the site for 2.5 years after the tenant abandoned. Kallman v. Radioshack Corp., 315 F.3d 731 (7th Cir. 2003).

A landlord should also be careful not to impose too harsh lease terms when dealing with a new tenant.  In Danada Square, LLC v. KFC National Management Co., 392 Ill.App.3d 598 (2d Dist. 2009), the court found that the landlord failed to mitigate when it offered a lease to the tenant with a 60-day “kick-out clause” – the landlord can terminate lease for any reason upon 60 days’ notice.

The take-away from all this is the landlord should promptly take steps to market a property once a tenant breaches a lease.  The landlord should also document its reletting efforts so it can prove in court that it mitigated its damages.