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Mitigation of Damages in Commercial Leases:
Sylva Shops Limited Partnership v. Hibbard
by Christina N. Freeman .
In a recent decision, the Court of Appeals addressed whether a party to a lease could contractually negate his obligation to mitigate damages in the event of a breach. The longstanding rule in North Carolina has been that the non-breaching party has a duty to mitigate his damages and failure to do so would result in an award of damages offset by those damages he could have reasonably avoided. Isbey v. Crews, 55 N.C. App. 47, 51, 284 S.E.2d 534, 537 (1981).
Summary of the Facts:
In Sylva Shops Limited Partnership v. Hibbard, the individual defendant tenant entered into a five-year lease with the owner of a shopping center located in Sylva, North Carolina. The tenant leased an out-parcel to open a bagel shop. After six months, the tenant closed the bagel shop and vacated the space. The plaintiff landlord attempted to rent the space with the assistance of a broker and, after some time, rented it for use as a sandwich restaurant.
The landlord then filed a complaint against the tenant for unpaid rent in addition to other unpaid expenses in connection with the lease. In support of a motion for summary judgment filed by the landlord, an affidavit was filed indicating that the landlord’s damages totaled $35,511.70. The trial court entered partial summary judgment in favor of the landlord but found that the tenant was entitled to an offset based upon the landlord’s failure to mitigate damages. Specifically, the tenant asserted that the landlord could have rented the space sooner but refused to accept a lower rent rate. Following a trial, the jury found that the landlord could have avoided $22,401.70 in damages and judgment was entered in favor of the landlord for $13,110.00. Both parties appealed the judgment.
The primary issue involved a clause in the lease that purported to “contract away” the landlord’s duty to mitigate damages. The clause reads as follows:
In no event shall Landlord’s termination of this Lease and/or Tenant’s right to possession of the Premises abrogate Tenant’s agreement to pay rent and additional charges due hereunder for the full term hereof. Following re-entry of the Demised Premises by Landlord, Tenant shall continue to pay all such rent and additional charges as same become due under the terms of this Lease, together with all other expenses incurred by Landlord in regaining possession until such time, if any, as Landlord relets same and the Demised Premises are occupied by such successor, it being understood that Landlord shall have no obligations to mitigate Tenant’s damages by reletting the Demised Premises.
Sylva Shops Ltd. P’ship v. Hibbard, ___ N.C. App. ___, 623 S.E.2d 785, 789 (2006). The tenant argued that this clause was contrary to the well-established law in North Carolina requiring the landlord to mitigate its damages and, accordingly, the clause was not permitted under the law.
Analysis of the Court of Appeals:
In its analysis, the court first considered whether the non-mitigation clause violated North Carolina law. The court discussed other instances in which parties have successfully contracted to relieve a party from a common law duty. One such instance is where parties have contracted to exempt themselves from liability for their own negligence. The court acknowledged that although such provisions were not favored and would be strictly construed against the parties relying upon them, they have been upheld under freedom to contract principles supporting the parties’ freedom to bind themselves as they choose. The court noted that such a provision would be stricken only in such instances where a statute was violated, where there was “inequality of bargaining power,” or where the provision was contrary to a “substantial public interest.” Id. at 790 (quoting Fortson v. McClellan, 131 N.C. App. 635, 636, 508 S.E.2d 549, 551 (1998)).
In the Sylva Shops case, the court noted that there was no violation of a statute and the parties did not allege an inequality of bargaining power. Rather, both parties employed brokers or advisors to assist with lease negotiations. The tenant testified that it chose this particular space because it considered the premises to be the best location for its business and acknowledged that it was not forced to sign the lease. Based upon these facts, the court concluded that the parties were on equal footing with regard to negotiating the lease.
The court then considered whether the clause violated public policy, defined as creating a tendency to cause injury to the public or the rights of third parties. The court noted that the lease was a private contract and did not risk the rights of the public or third parties. In response to the tenant’s argument that such non-mitigation clauses would harm small business and residential tenants, the court stated that its ruling was applicable only to commercial leases and noted that numerous other states did not impose a duty to mitigate damages. It stated that the parties to commercial leases typically enjoy equal bargaining power due to the availability of other space for lease and the fact that neither party is compelled to enter into a lease.
The tenant also argued the non-mitigation clause violated public policy when considered in combination with a provision in the lease that prohibited assignment of the lease without, in the landlord’s sole discretion, the landlord’s approval. The court rejected this argument, declining to alter a lease when previously negotiated provisions later proved to be disadvantageous to the complaining party. The trial court’s judgment was vacated and remanded for entry of judgment in the amount of $35,511.70.
Practice Points:
- This decision is applicable only to commercial leases and the court specifically stated that it would not extend to residential leases.
- A non-breaching party continues to be obligated to mitigate damages unless the lease contains a non-mitigation clause. Important factors to consider when including a non-mitigation clause in a lease would be the availability of comparable space in the area, whether the parties employed brokers and/or were represented by attorneys in the negotiations, and any other factor or factors that would suggest inequality of bargaining power between the parties. One might assume that a non-mitigation clause will be strictly construed against the non-breaching party.
- The tenants in the Sylva Shops case did not allege inequality of bargaining power and the court appeared to give little, if any, consideration for the fact that the landlord represented a shopping center and the tenant a small business venture made up of individuals. In reality, a small business would be in a weaker position to negotiate favorable terms in a lease for space in a successful shopping center. The owner of the small business could choose another shopping center, but the likelihood of business success might directly correlate to the success of the shopping center.
- A tenant may consider negotiating less restrictive rights to assign or sublease in the event the landlord insists upon a non-mitigation clause. A tenant may also consider negotiating a shorter lease term with renewal options.
Finally, unless the General Assembly passes legislation requiring non-breaching parties to mitigate damages, the Sylva Shops case establishes that parties to a lease may “contract away” this obligation. Based upon the court’s analysis, it appears that establishing inequality of bargaining power is the most likely method of challenging a non-mitigation clause. While the court enumerated only a few factors, both parties should be mindful of those and any other factors indicating that the parties were not on equal footing during the lease negotiations.
Christina N. Freeman is a Commercial Real Estate Associate with Schell Bray Aycock Abel & Livingston PLLC in the firm’s Greensboro office.
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