Landlord Rues the Day It Agreed to Late Delivery Fees

November 2019

In rue21, Inc. v. Los Lunas Inv’rs, LLC, No. 18-CV-715, 2019 U.S. Dist. LEXIS 51765 (W.D. Pa. Mar. 27, 2019), the U.S. District Court for the Western District of Pennsylvania reviewed a bankruptcy court’s order enforcing a liquidated damages clause in a commercial lease that allowed the tenant to recover more than two years’ worth of rent abatement as a result of the landlord’s delivery of the space fewer than three months late. The district court found the liquidated damages clause to be enforceable in its entirety, affirming the bankruptcy court’s order in part and reversing it in part.

In February 2016, rue21, Inc., a national retailer that sells apparel and accessories (“Tenant”) and Los Lunas Investors, LLC (“Landlord”) entered into a lease agreement (“Lease”) for a retail space in Los Lunas, New Mexico.  The Lease included a liquidated damages clause, which provided that “Tenant shall receive five (5) days of abatement of Minimum Rent and Other Charges . . . for each day that the Actual Delivery Date is delayed past the Target Delivery Date.  If the Actual Delivery Date is not delivered to Tenant within fifteen (15) days after the Target Delivery Date, then beginning with the sixteenth (16th) day . . . the Late Delivery Credit shall increase to ten (10) days of abatement . . . for each day of delay.”  Ultimately, Landlord delivered the space 84 days late, entitling Tenant to 755 days of rent abatement (for a total Late Delivery Credit of $191,415.41).

Upon Tenant’s subsequent filing for bankruptcy and filing of a notice of intent to assume the Lease, the parties disagreed about the cure amount for satisfaction of defaults under the Lease because Landlord argued that the liquidated damages clause with respect to the late delivery was unenforceable.  The bankruptcy court found that Landlord had the burden of proof and that the liquidated damages clause was partially enforceable to the extent it afforded five days of abatement for each day of delay.  However, the bankruptcy court also found that any additional increase in the Late Delivery Credit was a penalty and thus unenforceable.  Both parties appealed.

The district court narrowed its review to two central issues: (1) Whether the burden of proof lies with the party seeking to invalidate the liquidated damages clause or the party seeking to enforce the liquidated damages clause; and (2) Whether the liquidated damages clause was enforceable.

The district court affirmed the bankruptcy court’s finding that Landlord had the burden of proof because, under New Mexico law, the party seeking to invalidate the liquidated damages clause bears the burden of proof.  Therefore, in order to invalidate such clause, Landlord would have to demonstrate that it was so extravagant or disproportionate as to show fraud, mistake, or oppression.  The district court agreed with the bankruptcy court that there was no evidence of fraud or oppression, and that Landlord failed to prove there was a mistake, given that the liquidated damages clause was in both the letter of intent and the Lease and was based on a mutually predetermined per day credit.  Although Landlord argued that the liquidated damages clause was extravagant and/or disproportionate “on its face” because the application of the clause translates into over two years’ worth of rent abatement for a delivery that was fewer than three months late, the court found that such comparison was irrelevant because the liquidated damages calculation at issue was meant to be an estimation of anticipated damages that would be incurred by Tenant for failure of Landlord to deliver the property on time, not how much that figure would eventually equal in terms of rent.  The liquidated damages did not have to equal the actual damages of Tenant because they were only an estimate.  Thus, the district court determined that, under New Mexico law, the liquidated damages clause was generally enforceable.

Adding insult to injury for Landlord, the district court diverged from the bankruptcy court’s finding that the increase in the Late Delivery Credit was unenforceable—it found that the bankruptcy court erred when it stated that, “ . . . I think the case law suggests that you [Tenant] have to show that you’re somewhere in the ballpark” in connection with the increased rent credits, by improperly shifting the burden of proof back to Tenant to show that the increase was reasonable.  The bankruptcy court’s overall inquiry should have ended upon finding that Landlord failed to meet its initial burden.  Additionally, the district court found that the determination that an increase in the Late Delivery Credit was punitive was speculative at best and based on no evidence.  Accordingly, the district court reversed the bankruptcy court on this point and held that the liquidated damages clause was enforceable in its entirety.