What To Do In the Event of Default: Remedies for Breach of a Commercial Lease

By Bob Horvat
Disclaimer

Leases, like any other contract, contain default and remedy clauses.  However, since the possible consequences of a default under a lease can be catastrophic, remedy clauses in leases deserve even more careful scrutiny than remedy clauses in other kinds of contracts. From the landlord’s perspective, landlords do not believe that they should be required to negotiate with tenants about what the landlord may or may not do if the tenant fails to perform its agreed-upon obligations and defaults.  From the tenant’s perspective, while a landlord certainly should be entitled to take whatever steps it believes are necessary to protect itself following a tenant default, the landlord should also take such steps as are reasonable under the circumstances to minimize its own losses and thereby mitigate the damages for which the tenant will be liable.

Form leases prepared by landlords often omit to include a clause discussing the landlord’s default and the tenant’s remedies in such event.  Tenants should always insist that such a provision be included.  A typical landlord default/tenant remedy provision gives the landlord a thirty-day notice and opportunity to cure a landlord default, with a caveat that, if a default cannot reasonably be cured within thirty days, the landlord will not be in default so long as it commences the cure within such period and pursues it diligently to completion.  In the event of an uncured landlord default, Tenants should have the right to damages, specific performance, and injunctive relief, as well as the right to cure a default on the landlord’s part at the landlord’s expense.  The latter is usually the most effective remedy that a tenant can have.  Therefore, the lease should not only give the tenant the right to perform an obligation that the landlord does not perform within the applicable grace and cure period, but should also require the landlord to reimburse the tenant within a specified period of time for the commercially-reasonable expenses incurred by the tenant in performing that obligation.  Many tenants often attempt to get a right to deduct such expended amounts from rent, but this is typically objected to by landlords since such tenant remedies are viewed upon with great disfavor by lenders.

As concerns the landlord’s remedies in the event of the tenant’s default, the landlord typically has the right to the basic remedies of terminating the lease, taking possession, with or without legal proceedings, and suing for damages.

Generally, self-help is available in Oregon cases involving commercial leases. Jordan v. Wilhelm, 95 Or. App. 528, 770 P.2d 74 (1989).  However, self-help can be dangerous for the landlord to employ and can expose the landlord to counterclaims for breach of the covenant of quiet enjoyment, conversion, wrongful eviction and/or trespass.  In any event, the landlord is not permitted to breach the peace in using self-help. ORS 105.105; Coughlin v. Miller, 106 Or. 46, 211 P. 163 (1922).

Rather than using self-help, landlords should consider using the statutorily-provided, expedited remedy in Oregon, Forcible Entry and Detainer (“FED”), covered at ORS 105.105 et seq.  FED is a statutory summary judicial proceeding to recover possession in which the only issue to be determined is entitlement to possession.  In commercial tenancies, an FED may be commenced without prior written notice, provided the tenant has been in default in rent for ten days, unless a different time period is provided for in a written lease. ORS 91.090, 105.115 (1)(a).  Of course, the lease may shorten or lengthen the grace period or impose a written notice requirement.  An FED action is permitted when the tenant is “holding contrary to any condition or covenant of the lease or is holding possession without any written lease or agreement”. ORS 105.115(1)(b).

A landlord may also bring an action for breach of the lease, even though the landlord should not combine an action for breach with an FED action since the advantage of the summary FED proceeding will be lost if it does so.  The landlord’s damages typically include delinquent rent, the cost to relet (tenant improvement costs, leasing commissions and free rent), and the present value of accelerated lost future rent for the expected time to relet, together with legal fees and other expenses incurred as a result of the breach.  US Nat’l Bank v. Homeland, 291 Or. 374, 631 P. 2d 761 (1981). Depending upon the specific remedies clause, all items identified in the lease are recoverable, including past rent; late fees; future rent, less mitigation, discounted to its present value; leasing commissions; abated rent; repairs; tenant improvements; interest; and attorneys’ fees. See Kulm v. Coast-to-Coast, 248 Or. 436, 432 P.2d1006 (1967).

With respect to rent acceleration, most landlord commercial lease forms provide for that remedy in the event of a default by the tenant.  Under such a provision, the landlord is allowed to collect the entire present value of the rental stream for the remainder of the lease term following a default.  This remedy is generally not available by statute but is enforceable if agreed upon in writing in the lease.  While some jurisdictions have found rent acceleration clauses to be unenforceable penalties, Oregon courts have long held that an acceleration clause is not a penalty or forfeiture but a matter of contract that merely advances the time when a debt is payable upon the occurrence of a contingency.  See Salishan Hills, Inc. v. Kriger, 62 Or. App. 84, 660 P. 2d 160 (1982); Federal Recovery of Washington, Inc. v. Wingfield, 162 Or. App. 150, 986 P. 2d 67 (1998).

Under the law of most states, without a contractual acceleration right, the landlord is required to collect the rent due under the lease from the tenant only as it becomes due (less the amount that the landlord is able to avoid through mitigation, if any).  As a practical matter, in the overwhelming majority of tenant defaults, the premises is eventually released by the landlord.  In the event that the replacement rental rent is higher than the rent under the terminated lease, there will be nothing for the landlord to collect once the new tenant commences payment of rent (absent other damages). Often, the only rental loss is the “downtime”, which is the time between the date on which the defaulting tenant ceases doing business from the premises and the date on which the new tenant starts paying rent.

If a landlord insists on an acceleration right, there are several compromises that knowledgeable tenants will often attempt to extract.  First of all, tenants want the acceleration remedy to apply only to the “net rental” (that is, the rental stated under the lease minus the fair rental value) and not the “gross rental” (the amount payable under the lease for the balance of the term without any offset for what the landlord should be able to obtain by reletting the premises).  Second, it is important to tenants that the discount and interest rates used in the acceleration clause be commercially reasonable.  Typically, the major portion of the damages payable by the tenant relates to future rent payable over the term of the lease.  In such an instance, it is the discount rate, and not the interest rate, that is most important.  Because landlords normally chose a relatively high default interest rate, tenants often offer to utilize a default discount rate equal to or substantially close to the default interest rate.  However, landlords will often insist that the discount rate be equal to or near the Federal Reserve rate, which tenants often consider to be a disguised penalty because it is so low.  Finally, some tenants try to limit the rent acceleration remedy to cases of monetary default where there is no good faith dispute concerning such monetary default.

Finally, a commercial lease landlord has a lien on and may retain all personal property in the premises owned by the tenant or occupant legally responsible for the rent, pursuant to the statutory landlord’s lien provided for in ORS 87.162.  The lien does not attach to money, apparel, negotiable instruments, leased property or property of a subtenant.  The lien attaches twenty days after rent becomes due or at the time the tenant attempts to remove personal property when rent is due.  While the lien may be foreclosed either judicially under ORS Chapter 88 or non-judicially (public auction) under ORS Chapter 87, the landlord should not sell the property by private sale (an auction) since it may subject itself to a conversion claim and punitive damages by doing so.

The question of whether a landlord has a duty to mitigate damages when a tenant defaults is a question on which courts are not in agreement.  The traditional law in this area is that the landlord is not required to mitigate its damages, and has three potential courses of action: (i) let the property remain idle and collect all the accrued rent from the tenant at the end of the lease term, (ii) enter the premises for the sole purpose of reletting on the tenant’s behalf and minimizing its damages, which means that the landlord could still sue the tenant for the difference between the rent provided for in the lease and the rent for which it was able to relet the property, and (iii) terminate the lease and reenter the property.  This third option results in the tenant no longer being liable for rent to the landlord after its reentry.  The recent trend in the law has been to eliminate the first option and impose a duty on the landlord to mitigate damages.  Under Oregon law, a landlord has the burden of proof to show that it made an adequate attempt to mitigate its damages following a tenant’s default.  See Wright v. Bauman, 239 Or. 410, 398 P. 2d 119 (1965); Portland General Electric v. Hershiser, Mitchell, Mowery & Davis, 86 Or. App. 40, 738 P. 2d 593 (1987).

The final remedy that may be available under a commercial lease, if it is expressly provided for, is arbitration. Arbitration is often used in several different contexts in commercial leases.  For example, arbitration, especially “baseball arbitration”, is often used to settle rent disputes at renewal time. However, more and more landlords and tenants are agreeing in advance to use arbitration to settle all (or almost all) lease disputes.

Leases containing mandatory arbitration clauses typically require that the arbitration be conducted in accordance with the rules of the American Arbitration Association (“AAA”).  However, there are numerous problems with the AAA rules that the parties should specifically address in the lease arbitration provision.  Specifically, the lease language should:

(a) Require that arbitrators have not less than ten years landlord-tenant or general real estate law experience.  Once the landlord and tenant have each chosen one arbitrator, both arbitrators should then jointly choose a third panel member with similar experience.

(b) State that if either the landlord or the tenant does not select a panel member within a set time period, the non-delaying party will have the right to step in and select the unappointed arbitrator.

(c) Set a maximum period within which the arbitrators must reach their decision.  Sixty days is a typical time period.

(d) Include in the lease a schedule for exchanging documents, other evidence and witness lists to be used at the arbitration hearing.  The arbitrators also should be required to review this information before the hearing to decide if any of the material cannot be used. This gives each party access to much-needed information about the opposing party’s case, lets each party know beforehand if it will have a problem using any of its material, and keeps the arbitration process moving smoothly and on schedule.

(e) Provide that neither the landlord nor the tenant will have the right to appeal the panel’s decision unless such party is claiming fraud or corruption by one of the arbitrators.  Even if the loser does appeal on these grounds, the arbitrators’ decision should be enforced until the appeal  is decided. If the outcome is different from the arbitration results, the decision can be corrected.

(f) Discourage frivolous complaints by requiring the losing party to pay for everything, including both parties’ attorneys’ fees and all three arbitrators’ fees.  If there are several issues in the arbitration, the losing party on each issue should be required to pay the pro rata share of the costs for that issue.

(g) Finally, provide that the winning party will provide an itemization of its attorneys’ fees to the arbitration panel.  The panel will review the list to make sure the fees are not excessive.  However, the losing party should not have the right to comment on the list.  If the panel decides that the fees are excessive, the panel should be required to decide the amount of attorneys’ fees to be awarded to the prevailing party.

It should also be noted that Oregon, by statute, provides that all persons desiring to settle by arbitration any controversy, except as respects the terms or conditions of employment under collective contracts between employers and employees or between employers and associations of employees, may submit their differences to an arbitrator or arbitrators.  ORS 36.300.  A provision in any written contract to settle by arbitration a controversy arising out of that contract or out of the refusal to perform pursuant to that contract, or an agreement in writing between parties to submit any controversy that exists between them to arbitration, is valid, irrevocable and enforceable, provided that the arbitration is held within the State of Oregon.  ORS 36.305.  Therefore, in the event that a lease fails to specifically address the rules pursuant to which an arbitration will be conducted and merely provides that all or certain matters “shall be submitted to arbitration”, the Oregon Arbitration Act, ORS 36.300 et seq, will govern such arbitration.  Of course, from the perspective of both parties, it is far preferable from both cost and time standpoints to agree in advance on the rules that will govern the arbitration of a lease dispute.

Therefore, a commercial landlord or tenant faced with a default by the other party has many different remedies available under common law and on statutory and contractual grounds. However, each of these remedies should be carefully evaluated before proceeding and, in every case, careful attention should be paid to the written provisions of the lease itself.