Why Are Obnoxious Holdover Rents Enforceable?

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Is a holdover rent of 200% or even 150% an unenforceable penalty or does it just give the tenant an option: pay it or leave? Earlier this month, a California appellate court answered that question for its jurisdiction, but not without a lengthy analytic dissent.

To get us all on the same page, here are some ground rule definitions. “Holdover” by a tenant means it stays in the space, without its landlord’s consent, after the term of its lease expires. [For a lengthier exposition, click HERE for an earlier blog posting.] As to whether such a cranked-up rent constitutes enforceable, agreed-upon, liquidated damages or an unenforceable penalty, we need to review what constitutes legitimate liquidated damages. That’s because if an agreement, such as a lease, specifies an amount to be paid by a party upon breach of its agreement, that agreed-upon amount needs to be a reasonable estimate, made at the time of agreement, of what the damaged party would lose upon such a breach in a situation where the damages, if calculated at the time of the breach, would definitely exist, but would be very difficult to calculate exactly. [For a lengthier exposition, click HERE for yet another earlier blog posting.]

Our opening question isn’t one in a lot of states. For example, New Jersey has a “holdover” statute. By law, unless the parties agree otherwise, a tenant that remains in its space beyond the end of its lease’s term and that doesn’t leave after receiving a “notice to quit,” must pay “at the rate of double the yearly value of the real estate so detained, for so long a time as the same is detained.” California has no such statute.

The issue in the case we’re looking at, one that readers can see by clicking: HERE, deals with a provision in a very commonly used lease form promulgated by a real estate brokers’ trade group. It reads as follows:

26. No Right To Holdover. Lessee has no right to retain possession of the Premises or any part thereof beyond the expiration or termination of this Lease. In the event that Lessee holds over, then the Base Rent shall be increased to 150% of the Base Rent applicable immediately preceding the expiration or termination. Holdover Base Rent shall be calculated on a monthly basis. Nothing contained herein shall be construed as consent by Lessor to any holding over by Lessee.

[As an aside, it was suggested that the trade group contemplated whether to write a bigger percentage into this clause given that its research showed leases commonly called for 200%. It wound up deciding that 150% was fair and a good compromise for the generic landlord and its generic tenant.]

Readers, keep in mind that if the California appellate court rejected the 150% holdover rent as an unenforceable penalty, as was the case with the lower court decision it was reviewing, tens if not hundreds of thousands of commercial leases would be affected. So, as you read further, it would be legitimate to believe that the court’s majority, in [SPOILER] upholding the 150% rate (and impliedly a 200% or even a 500% rate), may have been giving-in to marketplace reality. There’s also a small wrinkle, written about but not analyzed in the court’s decision. When the tenant was facing the end of its lease term, it and its landlord amended the lease to extend the term for a month before the holdover rent would kick in. The landlord had sold the property and promised delivery free of tenancies. This “wrinkle” was not a listed factor in the court’s decision.

Prior California case law had held that “[c]ommercial provisions of this sort are enforceable even if the increased rent is much greater than the base rent.” That language comes from a 1942 court decision enforcing a 500% increase. Approvingly, the 2020 court adopted the earlier court’s “presumption that the leasing market is competitive and that market actors are freely able to contract in their own best interest.” To that, it added its own gloss:

This presumption of competition in the commercial leasing market fits common experience. In Southern California, at least, many different people own many different parcels of land. These are the sellers in the leasing market. The buyers in this market are the many enterprises that would like to lease those commercial premises.

And, it repeated the following from the nearly 80- year old decision:

Transactors in a competitive market are “free from obligation to each other” when they enter their lease contract.” … “They dealt at arm’s length. Deliberately and free from coercion, they made the provision for the rental to be paid for the use of the premises after the expiration of the definite term. This they had the right to do.”

The landlord argued that the holdover “premium” rent was not even a measure of damages, but was a price set for alternative performance. The tenant could leave or could choose to pay the 150% rent. The majority, in essence, agreed, saying: “Nor was [the tenant] subject to coercion after the lease amendment. [The tenant] was at complete liberty to avoid the higher rent. It had merely to leave.”

So, for now, i.e., assuming neither the California legislature nor its Supreme Court steps in, if (in California] a tenant and landlord freely agree to a holdover rent of 150% or 200% (and maybe a lot more), a court will enforce such a provision and not even denominate it as a form of damages.

As a practical matter, the court may be right in accepting what the commercial marketplace accepts. Further, “land” may be different from other subject matters for an agreement. It is unique, expectations are different, and (in the old days) Kings were involved and to be protected. Intellectually, however, the court’s majority decision is troubling. The dissenting judge may be more intellectually honest in opining that a charge of 150% is both a form of damages and an unenforceable one at that.

A good place to begin is the dissenting judge’s opening gripe:

Under the majority’s new test, contracting parties need not attempt to tether a liquidated damages provision to estimated anticipated losses; instead a challenger must analyze each contracting party’s respective market power and persuade a court that there was enough of an imbalance of market power between the parties to invalidate the damages provision.

The bone to be picked is that a holdover rent provision is not one for “alternative performance.” An example of “alternative performance” would be that of a tenant’s lease extension option. If a tenant has the option to extend its lease’s term for five years at 10 times the original rent, it can choose to stay at that higher rent, in which case its landlord must accept the continuing tenancy, or it can quit at the end of the initial term. Another example is one cited in the dissent:

A classic example of a valid option for alternative performance is described in [a prior loan case], that is, a pre-payment penalty for paying off a loan early at the option of the borrowers. Payment before maturity is not a breach of the loan contract, but simply an alternative mode of performance by the borrower. Indeed, for that reason, according to [that prior loan case], it is a misnomer to call it a penalty in the sense of retribution for a breach of the agreement.

In the case of the broker-form lease, a tenant does not have the right to remain in its space even if it pays rent at the 150% level. It is still a holdover tenant, removable by its landlord through an eviction action. “Pay the higher amount or leave” is not the same as “pay the higher amount and you can stay.”

The dissenting judge reached to yet another, earlier court decision to explain what is not “alternative performance.” That other court decision, also a loan case, had this to say:

Thus when it is manifest that a contract expressed to be performed in the alternative is in fact a contract contemplating but a single, definite performance with an additional charge contingent on the breach of that performance, the provision cannot escape examination in light of pertinent rules relative to the liquidation of damages.

So, is a provision in a pre-printed (or custom-drafted) lease establishing holdover rent at 150% of the base rent an unenforceable penalty? This California appellate court says “No,” but what do you think?

Is it a penalty or just a legitimate higher rent for the right to remain until the landlord decides otherwise? When contemplating that, keep in mind that if the landlord consents to a tenant staying beyond its lease’s term, there is no “holdover.” Consent negates a “holdover.” So, to call the 150% rent: “holdover rent” would be incorrect.

Is real estate so special that damages addressing the core principle of a lease, i.e. “money in exchange for the right of possession,” makes the measure of damages different than it would be for other agreements?

What would happen if states without a statutory holdover provision began finding these “figures” unenforceable?

OK, we know you are going to ask us, so here’s our answer. Ruminations thinks that because holdover provisions of up to 200% are so well (though not happily) accepted in the field of leasing, they are within the reasonable expectations of the parties and are therefore reasonable estimates of the damage a landlord would experience. That’s because the marketplace sets a lease’s normal rent based on the expectation that if the tenant holds over, the tenant will be exposed to the higher, (up to) 200% damages. If courts strike down these high holdover rents, the market rent, to begin with, would be higher. OK, yes, Ruminations is rationalizing a bit, but we always look for a marketplace explanation even ones that could fairly be called a rationalization.

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Comments

  1. A first draft, landlord-oriented lease that I recently reviewed calls for holdover rent at the greater of: (a) 200% of the expiring base rent or (b) 200% of the then fair market rent reasonably determined by Landlord. Do you think the California appellate court would have ruled differently on this provision since DOUBLING the REASONABLY determined FAIR market rent yields a rate that is both UNREASONABLE and UNFAIR?

  2. Elliot L. Warm,. General Counsel says:

    The problem is that we don’t know the true damages that a landlord could incur for failure of a tenant to vacate timely; it can’t be estimated in advance. If, for example, the inability of the landlord to have possession of the space causes loss of a long-term lease with a prospective replacement tenant of national stature, the damages could be far beyond what would be compensated by double rent for a short period of time. Thus, the purpose of hitting the tenant with a high, or even exceedingly high, amount of holdover rent is to force the tenant to leave rather than to stay and pay. If the increase were, say, 125% (as many tenants negotiate for), that might be nothing more than what the tenant would have to pay were it to renew or extend the lease, and the tenant may hardly be impelled to vacate in that situation. I think the lesson of this is that a landlord must keep it open to collect ACTUAL damages if the situation merits it. Holdover rent is NOT liquidated damages.

  3. Conceptually, rent is the price charged for occupancy for a slice of time. At expiry, the time slice ends and the lease is over. Staying is taking something new from landlord – occupancy for a new and different slice of time. Jacking up the rent is not a penalty for not leaving. It is the price of staying in occupancy without negotiating the right of occupancy. And its a price landlord could of course impose in a new pricing negotiation without fear of price gouging claims. Tenant is free to say no and leave, avoiding the increased rent – and, in fact, tenant already agreed to do so. So “holdover rent” is in no way a penalty for tenant’s breach of its obligation to surrender, but rather it is just the pre-negotiated price of having any new slice of time. And as all judges know Cali real estate value can skyrocket in a short period, so every time slice has unique value. That’s why the Cali courts have been so flexible on the issue. Similarly, while Cali has a strong anti-usury policy in its Constitution, it applies only to a loan or forbearance of money. But sales terms for credit (charge cards, credit sales, layaway, seller financing etc) are neither a loan nor a forbearance, they are just the pricing terms of the transaction, which the Courts recognize are neither a loan nor a forbearance, and thus are not subject to usury law. Cali usury law has been rendered a tiny niche as a result of that approach.

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