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Rent Abatement As Liquidated Damages Or Unenforceable Penalty?

By Gary A. Goodman, Michael S. Wien and Lisa J. Teich

Sophisticated parties engaging in complex real estate transactions customarily provide for rent abatement provisions in commercial office leases in order to liquidate damages where delays in landlord's construction would lead to a breach of the contract. That is what occurred in Bates Advertising USA, Inc. v. 498 Seventh, LLC, 291 A.D. 2d 179 (1st Dept. 2002). In a decision that threatened to have a profound impact on commercial office leases in New York City, the New York State Supreme Court, New York County, a trial level court, held a typical rent abatement clause unenforceable by ruling that it was not a liquidated damages provision, but instead, an unenforceable penalty. The tenant appealed, and in a decision that saved the contractual expectations embodied in many similar commercial leases, the Appellate Division's First Department reversed, finding that nothing in the rent abatement provision created an unenforceable penalty or forfeiture, or violated the purpose of the liquidated damages rule.

Liquidated damages constitute the compensation that the parties have previously agreed should be paid in order to satisfy any loss or injury flowing from a breach of their contract. Provisions for liquidated damages have value in those situations where it would be difficult, if not impossible, to calculate the amount of actual damage. Thus, in effect, a liquidated damages provision is an estimate, made by the parties at the time of contracting, of the injury that would be sustained as a result of a breach of the agreement. Liquidated damages provisions are struck down as unenforceable penalties when they are against public policy or 'the amount fixed is plainly or grossly disproportionate to the probable loss.' Truck Rent-A-Center v. Puritan Farms 2nd, Inc., 41 N.Y. 2d 420, 425 (1977).

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