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A unanimous three-judge panel of the Fourth Circuit Court of Appeals issued useful guidance to Maryland’s commercial leasing community concerning a landlord’s obligations to mitigate its damages following a tenant’s default in NCO Financial Sys., Inc. v. Montgomery Park, LLC, No. 17-2226 (4th Cir., Mar. 15, 2019). In this case, the tenant, eight years into a 12-year lease term discontinued its operations in a commercial office park, stopped paying rent and left the building.
The controversy examined by the Fourth Circuit was not whether the tenant defaulted on its obligations pursuant to the lease terms - indeed it had, but rather the measure of Landlord’s damages because of the default. The Fourth Circuit raises the importance of addressing the obligation to re-let contingency through careful drafting of the commercial lease.
A Brief History - The Duty to Mitigate under Maryland Common Law
Absent specific lease language to address a tenant’s unauthorized vacating of the leased premises, Maryland’s common law traditionally recognized three options for a landlord to remedy the tenant’s breach; specifically,
- the landlord may accept the surrender of the premises and agree to a premature termination of the contract;
- the landlord may reenter, attempt to re-let the premises and hold the tenant liable for the accrued rent between the time of reentry and tenant’s abandonment; or
- the landlord may simply do nothing and hold the tenant liable for the rest of the term. See, e.g., Wilson v. Ruhl, 356 A.2d 544, 546 (Md. 1976); Millison v. Clarke, 413 A.2d 198 (Md. 1980).
In a 2003 case Circuit City Stores, Inc. v. Rockville Pike Joint Venture Limited Partnership, the Court of Appeals of Maryland clarified Maryland law relating to a commercial landlord's duty to mitigate damages following a default by a tenant, ruling that if a landlord terminates a lease, or accepts a surrender of possession of the premises, it has a duty to use reasonable efforts to mitigate damages.
Key Takeaways from the Decision
The lease reviewed by the court in NCO v. Montgomery Park included express language that addressed the circumstances of the tenant vacating prior to the expiration of its lease term:
Landlord shall not be liable for, nor shall Tenant's obligations hereunder be diminished by reason of, any failure by Landlord to relet the Premises or any failure by Landlord to collect any rent due upon such reletting, but Landlord does agree to use reasonable commercial efforts to mitigate damages . . .
In assessing the propriety of the landlord’s conduct, the Fourth Circuit held that a failure to mitigate damages, if proven by the tenant, may serve to decrease the Landlord’s recoverable damages, but does not entirely foreclose the Landlord’s recovery of damages. The proper prism to apply the mitigation-of-damages doctrine, requires the tenant to demonstrate how much, if any, additional rent the landlord could have collected by exercising “reasonable commercial efforts” to re-let the space and then decrease the landlord’s contract damages by such amount. The circuit court sent the case back to the district court for that determination.
The Fourth Circuit also made clear that in discharging its “reasonable commercial efforts” to re-let to abandoned space, a landlord is not required to preferentially market or highlight the vacated space over the Landlord’s other available space. As such, a landlord’s duty-to-mitigate only requires that the landlord act reasonably, under the circumstances, to market the abandoned space on “equal footing” with other vacant spaces it is seeking to rent.
Lessons for Landlords
In light of the Fourth Circuit’s holdings, it is recommended that lease clauses addressing a landlord’s recovery of damages specify the extent of “reasonable commercial efforts” required to be used by a landlord. From the landlord’s perspective, it would be worthwhile to circumscribe the commercial efforts that must be pursued by the landlord to satisfy its mitigation efforts, for example that:
- Landlord not be required to solicit or entertain negotiations with any Substitute Tenant until Landlord obtains full and complete possession of the Leased Premises;
- Landlord not be required to lease the Leased Premises to a Substitute Tenant for less than the current fair market value of the Leased Premises, or under other terms and conditions that are unacceptable to Landlord, in its reasonable discretion;
- Landlord not be obligated to enter into a lease with a Substitute Tenant:
- whose use would adversely affect the reputation of the Building or Landlord;
- whose use would require additions to or modifications of the Building or Leased Premises in order to comply with current law, including building codes;
- that does not meet Landlord’s reasonable standards for tenants of the Building; or
- if space is available in the Building or in other properties owned by Landlord which is vacant or about to become vacant; and
- Landlord not be required to expend any amount of money to alter, remodel or otherwise make the Leased Premises suitable for use by a Substitute Tenant.
In addition, landlords and their legal counsel may want to define the efforts that must be pursued by the landlord to establish a clear path to the landlord’s compliance with its duty-to-mitigate. These actions may include:
- advertising and signage designating the premises for lease;
- listing the premises with commercial real estate brokers;
- undertaking a fair market valuation for the premises;
- remaining out the premises except for prospective tenant tours and maintenance.
The landlord may also want to consider the inclusion of a waiver of the common law mitigation duty entirely, however, this aggressive posture may (and should) garner spirited pushback from most tenants. Although Maryland has not forbidden such a waiver to date in commercial leases, public policy considerations could potentially jeopardize the waiver’s enforceability.
Conversely, tenants would seek to broaden the landlord’s obligations concerning the duty-to-mitigate, perhaps requiring a landlord’s “best efforts” or similar higher standard. Tenants should also consider the inclusion of lease language compelling the landlord to promptly complete affirmative actions following a tenant’s surrender of the premises, including the requirement that the landlord follow up with prospective tenants interested in the premises and to keep the tenant apprised of these efforts.
During lease negotiations, it is recommended to discuss and draft lease language setting forth specific examples of what constitutes satisfactory efforts by the landlord to mitigate its damages. That way, more clarity is achieved and party expectations, both for the landlord and tenant, can be set.
Keith O. Hinder, Jr., Esq. practices in the Commercial Real Estate Department at Niles, Barton & Wilmer, LLP, representing clients in commercial real estate matters and real estate and commercial litigation.see all Commercial Real Estate articles »
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