The recent Texas case Parvizian Fine Oriental Rugs, Inc. v Electic Design, LP, No. 14-22-00264-CV (Tex. App. Oct. 26, 2023), highlights the critical importance of carefully negotiating default clauses in commercial leases.  In this case, Parvizian (the Tenant) entered into a five-year lease in March 2016 with Eclectic (the Landlord) for the purpose of operating a rug selling business from a 9,000 square foot space.  The lease provided that if the Tenant failed to pay rent, the Landlord could recover possession and various damages from the Tenant.  These damages included unpaid rent for the remaining term, broker fees in connection with re-letting the premises, the cost of “repairing, altering, remodeling, or otherwise putting the Premises into a condition acceptable to such [new] tenant or tenants,” and attorneys’ fees.  The following year the president and principal owner of the Tenant died, and the Tenant stopped paying rent.  The Landlord sued, and the trial court ultimately awarded the Landlord damages of $447,984.52, which consisted of, among other amounts, $125,563.55 for costs to remodel the space into two separate units.  The Landlord explained that it tried to re-lease the premises to one replacement tenant, but there was no interest for such a large space, so the Landlord ended up dividing the space into two separate units and successfully leased them to two replacement tenants.

On appeal, the Tenant raised several objections to the amount of damages awarded and specifically questioned the enforceability of the lease’s damages clause.  The Tenant argued that it was unconscionable to allow the Landlord to “completely remodel the premises to the subjective liking of new tenants” and to allow the Landlord to “substantially upgrade” the premises by making capital improvements at the Tenant’s expense.  The Tenant further argued that the Landlord could have taken the “remodel” clause to an extreme and charged the Tenant to remodel the premises “in solid gold.”

The court rejected these arguments, stating that there is “nothing inherently unconscionable” about the “remodel” clause.  The court explained that the Tenant failed to provide any evidence that the Landlord overcharged the Tenant, and more importantly, it noted that the Landlord was already limited in the amount of damages it could charge the Tenant based on the Landlord’s obligation to mitigate its damages under Texas law.  In other words, had the Landlord tried to remodel the premises in solid gold, the Tenant could have avoided paying for such costs by showing that Landlord’s actions were excessive and violated its obligations to mitigate its damages arising out of the Tenant’s default.

One tactic the Tenant could have used to give itself a better chance for success is to provide evidence that the remodeling costs were unnecessary.  However, it seems unlikely this effort would have resulted in meaningful cost savings under the facts of this case.  Another way that some tenants with leverage try to protect against this outcome is to revise the “remodel” provision in the lease to state that the tenant is only responsible for Landlord’s costs to restore the premises to the same condition that the tenant is required to surrender the premises in on the expiration date of the lease.  While this protection would prevent a tenant from having to pay for remodeling costs, it could also prevent a landlord from finding replacement tenants that would otherwise offset the remaining rent to be owed to the landlord for the remaining term.  Still, most tenants would prefer to have this protection and to have the option to approve remodeling costs upfront.