Liquidated Damages Provision Based on Notice of Intention to Redevelop Property Not Enforceable When Tenancy Not Terminated

On May 25, 2021, Justice Borrok of the New York County Commercial Division issued a decision in Prada USA Corp. v. 724 Fifth Fee Owner LLC, 2021 NY Slip Op. 50494(U), holding that a liquidated damages provision based on notice of an intention to redevelop a property was not enforceable when the tenancy was not terminated, explaining:

As this court previously discussed, under the Lease, the parties agreed that in the event that the Owner exercised the Suspension provisions—because the Owner was contemplating a redevelopment of the Building — then, Prada's tenancy and rent would be suspended and Prada would receive as liquidated damages up to $5,000,000 (depending on when the Suspension Date occurred) to compensate it for being displaced from its occupancy in the demised premises until the Anticipated Reinstatement Date occurs. The Anticipated Reinstatement Date was to be not later than three years after the Suspension Date identified in the Suspension Notice. Additionally, the parties agreed that the Owner would be obligated, as part of the redevelopment of the Building, to rebuild Prada's demised premises based on Prada selecting a build out model from selections offered by the Owner (i.e., Prada would be given a replacement store). It is established that the Owner activated the Suspension provisions, and that Prada made the required selection, which ripened these provisions into an enforceable set of obligations. As previously discussed, prior to the time of the Prior Decision, the Owner decided that it was not redeveloping the Building because it is no longer feasible to do so. Prada, in turn, did not vacate the demised premises and instead continued to occupy the demised premises and pay rent.

Although the Suspension Notice is not revocable, Prada does not now have the right (based on the Lease or otherwise) to compel the Owner to redevelop the Building. Nor is Prada entitled to the $5,000,000 liquidated damages provided for in the Lease if Prada's occupancy were to be suspended by the Owner because the suspension of Prada's tenancy, premised on the Owner's redevelopment, is not now going to occur. The money available under the Suspension provisions were negotiated liquidated damages designed to constitute the compensation that the parties agreed should be paid for the loss or injury flowing from an agreed suspension of their contract — which suspension would otherwise be a breach of Prada's tenancy. To be enforceable, a liquidated damages clause cannot be a penalty (nor render a windfall), but must bear a reasonable proportion to the probable loss and the amount of actual loss must be impossible or difficult to precisely estimate. Where the amount fixed as liquidated damages is plainly or grossly disproportionate to the probable loss, the provision calls for a penalty and will not be enforced. To determine whether a contractual provision constitutes liquidated damages or a penalty, the contract must be interpreted as of the date of its execution, not the date of its breach. In other words, the court must look to the anticipated loss discernible at the time of contracting and not the actual loss incurred by the breach to determine whether liquidated damages are reasonable or whether the damages were capable of calculation. The burden is on the party challenging the liquidated damages provision to show that such damages are an unenforceable penalty.

It is beyond cavil that enforcement of the $5,000,000 liquidated damage provision that was intended solely to compensate Prada for a suspension of its tenancy in connection with a redevelopment of the Building that is not now occurring constitutes an unreasonable penalty. However, as discussed in the Prior Decision, the Suspension Notice was irrevocable, and Prada is entitled to the actual costs incurred by virtue of it being inconvenienced in connection with the same, including without limitation, any third party costs in connection with the review of the new store design proposals sent by the Owner to Prada. Put another way, the approximately $5,000,000 liquidated damages were meant to put the parties in as close a position as they could be notwithstanding a redevelopment-related suspension. Neither party can profit from or arbitrate on a suspension notice that did not result in a surrender of occupancy or an actual renovation-related suspension or change to the premises. The only potential issue for trial is whether, in the absence of a renovation, Prada has suffered a demonstrable harm (e.g., third party costs or other foreseeable reasonable costs incurred prior to receiving notice from the Owner of its intention not to proceed with the proposed Building redevelopment). The Lease provides that attorney's fees are recoverable and as such Prada is entitled to its reasonable attorney's fees associated with responding to the Owner's attempt to revoke the Suspension Notice. Accordingly, except to the extent set forth herein, Prada's breach of contract claims must also be dismissed.

(Internal quotations and citations omitted).

We frequently litigate disputes over the leasing, purchase and sale of commercial property. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you are involved in a dispute regarding a commercial real estate transaction.