A lease provided that if the landlord failed to pay a construction allowance when due, the tenant debtor’s obligation to pay rent and charges abated until payment was received. The bankruptcy court interpreted this as a forfeiture provision so that the landlord was not entitled to set off the construction allowance against rents as they became due. The landlord appealed to the district court.
Key terms in the lease included the following:
- One section of the lease stated that the landlord “shall pay to [A&P] a $1.9 million construction allowance (the ‘Construction Allowance’) on or before the ninetieth day following the date that A&P opened its door to the public.”
- Another section stated that “if [the landlord] fails to pay the Construction Allowance, then A&P’s ‘obligation to pay fixed annual rents and Charges shall abate… until [A&P’s] receipt of the Construction Allowance, together with interest on the unpaid balance thereof as to Lease Interest Rate (as hereinafter defined).”
- The lease also provided that the tenant was to retain title to the improvements until it received payment of the Construction Allowance.
The store opened and the landlord had a loan commitment that was scheduled to close several days before the 90-day deadline for payment of the construction allowance. However, four days before the planned closing date, A&P filed bankruptcy. The landlord did not make the payment within the 90 days, and the debtor withheld rents and charges until the landlord paid the construction allowance about nine months later.
The landlord contended that the construction allowance should be reduced by the amount of the rent withheld by the debtor. The debtor countered that it was entitled to withhold and abate the rent for as long as the construction allowance was not paid.
Although the bankruptcy court was troubled by the windfall this gave the debtor, it concluded that abatement was an enforceable forfeiture provision under applicable state law. Consequently, the landlord was not entitled to set off the construction allowance payment against the withheld rent.
In reaching this conclusion, the bankruptcy court considered whether the abatement clause should be considered a liquidated damages, penalty, or forfeiture provision. Since it did not provide for payment of a specific sum of damages and instead just provided that the landlord’s right to receive rent was lost until it made the payment, the court concluded it was a forfeiture provision.
In considering whether the abatement provision was enforceable as a forfeiture, the bankruptcy court noted that this was simply a matter of contract construction and under state law courts would not interfere unless there was “fraud, accident, surprise or improper practice.”
On appeal, the district court focused on the clause that said the “obligation to pay fixed annual rent and Charges shall abate” if the construction allowance was not timely paid. Turning to Black’s Law Dictionary: “The term ‘abatement’ is defined as ‘[t]he act of eliminating or nullifying.’” Consequently, the district court agreed with the bankruptcy court that the landlord lost its right to receive rent and charges during the applicable period, and was not entitled to set off the rent accruing during that period against the amount due at the closing.
The landlord argued that the provision was unenforceable because it must be reasonable, and the debtor was already adequately compensated by receiving interest on the construction allowance until it was paid. In response, the district court noted that there was no requirement that a forfeiture be reasonable, and reiterated the bankruptcy court’s view that under state law courts would not disturb the provision unless there was evidence of fraud, accident, surprise or improper practice.
The landlord also sought to require the debtor to pay property taxes that had come up during the period that the landlord was delinquent on the construction allowance payment. However, the court concluded that the taxes were charges, and thus also subject to abatement.
Consequently, the court affirmed the bankruptcy court order granting summary judgment to the debtor, which meant that the debtor was not obligated to pay rent or charges for the period between the construction allowance payment deadline and the date on which it was actually paid.
If rent was being abated during a period when the tenant did not have use of the premises (for example through a casualty), it is logical that the tenant would never be required to pay that rent. Similarly, it would not be unusual to allow a tenant to set off rent against a reimbursement amount owed by the landlord to the tenant. However, requiring the landlord to forfeit rent due during the period that the landlord was delinquent in its reimbursement obligation is more surprising. It pays to be precise in drafting, and be forewarned that abatement of rent is not temporary.
Vicki R. Harding, Esq.