New York Court Appeals Holds Liquidated Damages Provision in a Surrender Agreement to Be an Unenforceable Penalty

• Posted on: Nov 30 2020

In Trustees of Columbia Univ. in the City of N.Y. v. D’Agostino Supermarkets, Inc., 2020 N.Y. Slip Op. 06937 (Nov. 24, 2020) (here), the New York Court of Appeals was asked to “consider the propriety of a liquidated damages provision in a Surrender Agreement between two New York City icons: Columbia University, one of the City’s premier universities, and D’Agostino Supermarkets, a family-owned food market chain founded in 1932.” Slip Op. at *1.

D’Agostino had leased property that was owned by Columbia University. The supermarket chain breached the lease by failing to pay rent for more than seven months. Rather than litigate, the parties settled the matter by entering into a Surrender Agreement. Under the agreement, if D’Agostino made timely installment payments, totaling about $262,000, representing the rent it already owed but had failed to pay, it would be relieved of certain other obligations stemming from its breach of the lease. However, if it failed to timely make the payments, D’Agostino would not “be released and relieved from” the claims Columbia agreed to release and would have to pay liquidated damages in “the aggregate amount of all Fixed Rent, additional rent or other sums and charges due” during the remainder of the lease term (about two years).

Defendant failed to timely pay the first four monthly surrender payments, despite plaintiff’s notice to cure. In November 2016, plaintiff commenced the underlying action to enforce the liquidated damages provision in the Surrender Agreement. After defendant answered, plaintiff moved for summary judgment seeking future payments under the terminated lease, i.e., $1,020,125.15, plus interest and other taxes and costs provided for under the lease. Plaintiff rejected defendant’s December 2020 tender of $175,751.73, which represented overdue and early payments of the remaining surrender installments. Defendant cross-moved for summary judgment striking the damages provision and seeking entry of judgment against itself for $175,751.73—the outstanding amount due under the Surrender Agreement—along with accrued interest as of October 14, 2016, or, in the alternative, denying plaintiff’s motion and ordering discovery on the issue of damages and mitigation based on the new lease.

The trial court denied plaintiff’s motion for summary judgment and granted defendant’s cross-motion for summary judgment for the requested amount and interest. The Appellate Division, First Department affirmed (168 A.D.3d 594 (1st Dept. 2019)). The Court granted plaintiff leave to appeal (33 N.Y.3d 904 (2019), and in a 4-3 decision written by Judge Rivera affirmed the Appellate Division’s decision.

A significant issue in the action was whether the damages provision should be “measured against defendant’s breach of the Surrender Agreement” or, “against the breach of the terminated lease.” Slip Op. at *3. The majority viewed the matter under the prism of the former, while the dissent viewed the dispute under the latter. Viewed as a breach of the Surrender Agreement, the Court concluded that the liquidated damages provision was “an unenforceable penalty because it [was] plainly disproportionate to the damages for the only contractual breach at issue in th[e] appeal, i.e., overdue payment of the monthly surrender installments.” Id.

Liquidated damages are “an estimate, made by the parties at the time they enter into their agreement, of the extent of the injury that would be sustained as a result of breach of the agreement.” Truck Rent-A-Ctr. v. Puritan Farms 2nd, 41 N.Y.2d 420, 424 (1977). “A liquidated damage provision has its basis in the principle of just compensation for loss. Id. (citing Restatement of Contracts § 339, and Comment thereon). “Liquidated damages that constitute a penalty, however, violate public policy, and are unenforceable. A provision which requires damages ‘grossly disproportionate to the amount of actual damages provides for [a] penalty and is unenforceable.’” 172 Van Duzer Realty Corp. v. Globe Alumni Student Assistance Assn., Inc., 24 N.Y.3d 528, 536 (2014) (citation omitted) (quoting Truck Rent-A-Ctr., 41 N.Y.2d at 424).

[This Blog wrote about liquidated damages here and here.]

The party seeking to avoid payment of liquidated damages has the burden of establishing that the damages for a breach are disproportionate to the foreseeable losses and “in fact, a penalty”. JMD Holding Corp. v. Congress Fin. Corp., 4 N.Y.3d 373, 380 (2005). The Court held that defendant met this burden.

The Court observed that the “damages provision effectively reinstated defendant’s future rent liabilities under the terminated lease, to the tune of $1,020,125.15, plus interest and other prospective taxes and costs due under the lease, even though those damages did not flow from a breach of the Surrender Agreement.” Slip Op. at *4. “Those damages,” said the Court, “were 7½ times what plaintiff would have received, if defendant had fully complied with the Surrender Agreement.” To permit plaintiff to recover that amount, reasoned the Court, would be tantamount to the enforcement of “a non-existent lease under the guise of damages for a breach of a separate contract.” Id. (footnote omitted).

To be clear, when the lease was in effect, plaintiff could have exercised its rights as the landowner and proceeded against defendant for violating the leasehold terms. Instead, plaintiff negotiated with defendant to terminate the lease in exchange for a set amount of money and surrender of the premises. That contract freed plaintiff from its lessor obligations. Critically, contrary to the dissent’s assertion that plaintiff “received nothing in exchange” (dissenting op at 5), it allowed plaintiff to immediately reenter and relet the premises without the need for litigation, which is exactly what it did.

When defendant breached the Surrender Agreement, plaintiff was entitled to proceed under that contract and demand damages for the breach, including the amount past due and acceleration of the remaining installment payments. 

Id. (citations omitted).

However, said the Court, “plaintiff could not seek a payment grossly disproportionate to the amount past due plus interest.” Id. The Court concluded that “[b]y any measure the more than one million dollars plus interest demanded here is disproportionate to the $175,751.73 unpaid under the Surrender Agreement.” Id. (citations omitted).

The Court posed “[a] simple hypothetical” to “illustrate[] the penalizing nature of the liquidated damages provision” under the Surrender Agreement. Id. at *5. 

According to plaintiff’s interpretation of the Surrender Agreement, if defendant timely made all but the final monthly surrender payment of $15,977.43, defendant’s breach would render it liable for $1,029,969.54 plus interest and additional costs. Defendant would be liable for the total amount remaining due under the terminated lease, and defendant would be forced to pay that amount, rather than the final installment, without having had the benefit of the premises which it had surrendered to plaintiff. There is but one way to refer to this outcome: an unenforceable penalty.

Id.

In finding the damages clause to be “an unenforceable penalty,” Judge Rivera relied on the Court’s decision in Van Duzer. There, like in Columbia Univ., the defendants maintained that the landowner’s acceleration of prospective rent was disproportionate to the landowner’s actual damages. As in Columbia Univ., the landowner terminated the lease and relet the premises after the tenant vacated. Without deciding whether the amount sought was a penalty, the Court held that the defendants were entitled to a hearing to present evidence that the undiscounted accelerated rent was disproportionate to the landowner’s actual losses, and thus constituted unenforceable liquidated damages. Van Duzer, 24 N.Y.3d at 536-537.

The majority rejected the dissent’s argument that the Surrender Agreement should be examined as a settlement agreement. Slip Op. at *5 (citing the dissenting op. at 3). The reason, said Judge Rivera, “a settlement agreement, like any other agreement, cannot be enforced if it violates public policy, including our state’s rejection of penalties as damages.” Id. (citations omitted). 

“Plaintiff’s real argument,” observed the majority, “is that it did not receive six payments on time, but that was the risk that it accepted by entering the Surrender Agreement.” Id. Such a risk (i.e., the risk of default), noted Judge Rivera, “is a risk common to all contracts, without unique effect in the context of a surrender of premises. And the existence of that risk does not and cannot justify exaction of a penalty.” Id.

Finally, the majority took issue with the dissent’s argument “that affirmance … would disincentivize landowners from entering surrender agreements and deprive tenants of the benefit afforded by such arrangements.” Id. “This approach,” explained Judge Rivera, “encourages surrender agreements as providing a benefit to all parties—the tenant is released from future liability and the landowner regains the premises and the opportunity to relet on its own account.” Id. “In contrast,” concluded Judge Rivera, “the dissent’s approach would disincentivize tenants from negotiating a mutually agreeable surrender because the tenant would remain on the hook for back rent, future rent and other contractual damages without the benefit of enjoyment of the premises.” Id.

Writing for the dissent, Chief Judge DiFiore argued that the majority opinion interfered with the public policy favoring the freedom to contract. Slip Op. at *5. This policy, said Chief Judge DiFiore, “applie[d] with particular force to the Surrender Agreement—which [was] a settlement agreement crafted by the parties to resolve their dispute without litigation.” Id. “Strict enforcement of settlement agreements serves multiple important purposes, consistent with those underlying freedom of contract,” observed Chief Judge DiFiore. Id. “[T]hese policies, and the significant interests they protect, should guide the resolution of this dispute between two sophisticated, counseled commercial entities.” Id.

Chief Judge DiFiore said the “majority cast[] these principles aside, failing to acknowledge that the Surrender Agreement constituted a settlement of the claims Columbia possessed upon D’Agostino’s breach of the lease, which included a right to collect—not only unpaid back rent—but also future rent owed until the conclusion of the lease term, even if D’Agostino vacated the premises (Columbia had no obligation under the lease to relet the property).” Id. at *5-*6. “The parties’ agreement could not be clearer,” explained Chief Judge DiFiore, “that Columbia waived certain claims it possessed arising from D’Agostino’s breach of the lease only if this condition—timely payment of the installments—was met.” Id. at *6. “Under the plain language of the agreement,” Chief Judge DiFiore noted, “upon D’Agostino’s default or failure to timely cure upon notice, two things would occur: D’Agostino would immediately be obligated to pay the future rent due under the lease (among other associated payments) and it would ‘no longer be entitled to be released and relieved from and against any Released Claims.’” Id. 

The dissent took issue with the majority’s conclusion “that the Surrender Agreement should be interpreted without reference to the prior breach of the lease and that D’Agostino was relieved of all obligations under the lease even if it failed to timely make the installment payments.” Id. 

Although the Surrender Agreement “terminated the lease,” it most certainly did not unconditionally release the tenant of all obligations flowing from its breach of that prior agreement, and the majority’s assertion that Columbia seeks to “enforce a non-existent lease under the guise of damages for a breach of a separate contract” (majority op at 8) misses the mark. Columbia does not attempt to enforce the lease—instead, it seeks to enforce the contingent remedy the parties adopted in the Surrender Agreement in the event D’Agostino failed to timely make the Surrender Payments.

Id.

The dissent found that the “public policy underlying our liquidated damages jurisprudence [was] simply not implicated in circumstances where, as in this case, there is no need to estimate the damages that might result in the event of a future breach because the breach has already occurred and the parties are crafting a settlement agreement.” Id. “But even viewing the contingent remedy as a liquidated damages clause,” said Judge DiFiore, “the majority’s conclusion that the provision reinstating D’Agostino’s obligation to pay future rent is an unenforceable penalty because it provides for damages ‘exponentially disproportionate’ to D’Agostino’s outstanding Surrender Payments (approximately $1 million versus $176,000) adopts an overly simplistic view of the Surrender Agreement and fail[ed] to ‘giv[e] due consideration to the nature of the contract and the circumstances’ in which it was entered….” Id. (citing Van Duzer, 24 N.Y.3d at 536) (footnote omitted). 

It is evident from the Surrender Agreement that the parties understood that D’Agostino’s liability for breach of the lease was much greater than the value of the Surrender Payments. The obligations triggered if those payments were not timely made were not included merely as compensation for breach of the Surrender Agreement but were also intended to compensate Columbia for D’Agostino’s earlier breach of the lease. Thus, an analysis of whether the damages set forth in the Surrender Agreement are grossly disproportionate to Columbia’s probable losses requires consideration not only of the value of the Surrender Payments that D’Agostino failed to make, but also of the probable damages already set in motion by D’Agostino’s prior breach of the lease, viewed from the time the Surrender Agreement was executed and not the date of the breach.

Id. (citation omitted).

Thus, explained the dissent, “[i]t is irrelevant that Columbia’s actual damages … may ultimately be different than the amount D’Agostino agreed to pay in the contingent remedy provision of the Surrender Agreement.” Id. “The enforceability of a liquidated damages clause,” further explained Chief Judge DiFiore, “does not turn on whether the remedy that the parties contemplated before the breach occurred is identical to the damages actually suffered.” Id. “To impose such a requirement,” reasoned the dissent, “would obviate the entire purpose of such provisions, which is to reasonably estimate the damages that might result, permitting the parties to avoid the costs and uncertainty of litigating damages in the event of a future breach.” Id. “For this reason,” concluded Chief Judge DiFiore, “the rough relationship between the remedy in the contract and the damages flowing from a breach must be assessed based on the terms of the agreement and the information the parties possessed at the time it was executed—not with the benefit of hindsight based on post hoc proof of damages actually incurred.” Id. at *6-*7.

In conclusion, the dissent said there was no competing public policy that negated the policy underlying the freedom to contract. Id. at *7.

Because there was nothing unfair about the settlement crafted by these well-counseled sophisticated parties, public policy affords no basis to alter their contract. Since the back rent payments were already substantially overdue, Columbia reasonably sought assurance that D’Agostino would uphold its end of the bargain under the Surrender Agreement (something it failed to do under the lease). As reflected in the plain language of the agreement, Columbia was willing to forego pursuit of its then-existing right to collect both unpaid back rent and future rent only if D’Agostino timely made the back rent installment payments (the owner gave up its right to receive more money overall but would be assured of prompt payment of a discounted amount on a regular schedule, without the need for litigation). Of course, that is not what happened. By eliminating the element that induced the owner to give up its rights, the majority creates a distorted, one-sided settlement in which—despite its default—D’Agostino was able to enjoy the full benefit of the bargain.

Id.