The COVID-19 pandemic hit commercial landlords and tenants hard. Many Minnesota businesses experienced a steep decline in revenue and, as a result, have been unable to either make their monthly rent payments or collect on the same.
Today, businesses with leased, store-front locations are still struggling to make ends meet. One of the first consequences of reduced revenues is an inability to fulfill commercial lease obligations. This in turn has a significant effect on landlords who have expenses to meet and mortgages to pay. With a loss of rental income, landlords may face foreclosure and loss of their property. As a result, commercial tenants and landlords are faced with a difficult decision. For tenants, should they (a) continue making partial rent payments, or (b) cut their losses, abandon the leased premises, and attempt to terminate their commercial lease agreement? For landlords, should they (a) accept partial payments and risk continued reductions in revenue, or (b) strictly enforce their contractual rights and remedies, including “accelerating” the lease and demanding all remaining rent payments, but ultimately obtain only a judgment, with little chance of recovery, at least in the short term? This is where acceleration clauses come into play.
An acceleration clause gives a landlord the right, after a default by the tenant (i.e., nonpayment of rent, abandonment of the premises, or any other event of default set forth in the agreement), to demand the entire balance of the unpaid rent owed under the lease for the entire remainder of the lease term. An acceleration clause allows the landlord to collect all remaining unpaid rent in one lump sum payment before the rent would otherwise be due. Under Minnesota law, if there is no acceleration clause, the landlord is typically entitled only to collect rent from the tenant as it becomes due under the lease.
Commercial tenants and landlords alike often wonder whether acceleration clauses are enforceable. In reality, the enforceability of an acceleration clause will have a direct and substantial impact on the financial health of both landlords and tenants. The short answer is that Minnesota courts will generally enforce acceleration clauses in commercial lease agreements, with some important caveats.
The Minnesota Court of Appeals holds that “Minnesota courts give effect to a lease provision that gives a lessor the right to recover rent through the end of the lease term, after a lessee has defaulted.” 1975 Robert St. Partners v. SR Shingle Creek LLLP, No. A07-0844, 2008 WL 2020480, at *5 (Minn. Ct. App. May 13, 2008) (citations omitted). Under Minnesota law commercial tenants could face substantial liability if they elect to stop making full payments and/or abandon the leased premises.
Many tenants incorrectly assume that the landlord is required to mitigate its damages by, for example, finding a replacement tenant to take over the premises. Much to the contrary, Minnesota law is clear that where the tenant abandons the premises but the lease agreement is not terminated, the landlord has no duty to mitigate its damages after abandonment. Control Data Corp. v. Metro Office Parks Co., 296 Minn. 302, 306 (1973). However, if the lease agreement is terminated, then the landlord generally has a duty to “use reasonable efforts” to mitigate its damages after the lease is breached. Lariat Companies, Inc. v. Baja Sol Cantina EP, LLC, No. A12-2202, 2013 WL 4404589, at *4 (Minn. Ct. App. Aug. 19, 2013) (citing Gruman v. Invs. Diversified Servs. Inc., 78 N.W.2d 377, 381 (1956)). In this scenario, the party who breaches the lease agreement (i.e., the non-paying tenant) has the burden of proving that the landlord could have mitigated its damages. Lanesboro Produce & Hatchery Co. v. Forthun, 16 N.W.2d 326, 328 (1944).
It is important to note that the above-described common law principles are general rules, and may be altered by the express terms of the applicable lease agreement. For example, the contracting parties may include provisions which provide that accelerated rents are not recoverable until the lease agreement is terminated, or that the landlord does have a duty to mitigate its damages even where the lease is not terminated. Minnesota courts usually enforce lease agreements as written, even if they contravene other common law principles. See RAM Mut. Ins. Co. v. Rohde, 820 N.W.2d 1, 14 (Minn. 2012) (citation omitted).
Even though courts are generally inclined to enforce acceleration clauses, there are potential defenses to enforcement. One potential defense is to show that the acceleration clause is really an unenforceable penalty clause in disguise, because it creates an inaccurate and unjust windfall in favor of the landlord. Minnesota courts appear to analyze acceleration clauses in a similar manner as liquidated damages provisions and penalty clauses.[1] See, e.g., In re Grodnik’s, Inc., 128 F. Supp. 941, 942 (D. Minn. 1955). A penalty clause is usually unenforceable because it is viewed as being disproportionate to the actual amount of damages suffered, whereas a liquidated damages provision is enforceable where: (a) the damages amount provided by the liquidated damages provision is “a reasonable forecast of just compensation for the harm that is caused by the [tenant’s] breach;” and (b) “the harm that is caused by the [tenant’s] breach is one that is incapable or very difficult of accurate estimation.” See Gorco Const. Co. v. Stein, 256 Minn. 476, 482, 99 N.W.2d 69, 74–75 (1959) (citation omitted). Under In re Grodnick’s, these rules appear to apply equally to acceleration clauses.
Applying these concepts, a commercial tenant may be able to avoid liability for future rents due under an acceleration clause if the clause does not include necessary limitations to ensure that the recoverable rents are adjusted on a reasonable basis so as to avoid a windfall in favor of the landlord. For instance, an acceleration clause generally must: (a) account to the breaching tenant for any rent received from a replacement tenant by deducting said amounts from the accelerated rent; and (b) discount for the present value of specific property. See, e.g., Lariat Companies, Inc. v. Baja Sol Cantina EP, LLC, No. A12-2202, 2013 WL 4404589, at *4 (Minn. Ct. App. Aug. 19, 2013); Restatement (Second) of Property, Land. & Ten. § 12.1, cmt. k (1977). If the acceleration clause does not include these limitations, it may constitute an unenforceable penalty, thereby precluding the landlord from recovering all, or some, of the accelerated rent amounts. Accordingly, it is in both landlords’ and tenants’ best interests to agree to an acceleration clause that is appropriately tailored.
Given the ongoing uncertainty surrounding the COVID-19 pandemic and its effects on businesses, it is imperative that commercial tenants and landlords alike diligently evaluate their duties and obligations before abandoning a property or terminating a lease agreement. Consulting an attorney could save your business and limit unnecessary losses. The law firm of Winthrop & Weinstine, P.A. boasts a wide array of experienced attorneys who can help your business navigate the nuances of a commercial lease dispute to ensure that you make informed, business-oriented decisions to avoid prospective liability.
[1] A liquidated damages clause is a contractual provision that specifies a predetermined amount of money that must be paid as damages for a parties’ failure to perform under a contract. The amount of the liquidated damages is supposed to be the parties’ best estimate at the time they sign the contract of the damages that would be caused by a breach. If a breach occurs and the liquidated damages clause is enforceable, the parties do not calculate the actual damages (i.e., how much money a party actually lost as a result of the breach). Instead, the breaching party pays the predetermined sum provided by the liquidated damages provision.
