Case: El Centro Mall, LLC v. Payless Shoesource, Inc., Cal. Court of Appeal, Fourth District, Division Three, No. G040038 (May 21, 2009)

The One Sentence Summary: In an action by landlord El Centro Mall seeking liquidated damages of $98,000 based on defendant Payless Shoesource’s closure of its store before expiration of the lease term, Payless failed to show that the liquidated damages did not represent a reasonable estimate of the actual damages a mall landlord would suffer as a result of a “national tenant” like Payless ceasing operation, and thus failed to rebut the presumption of validity of the lease’s liquidated damages provision.

What They Were Fighting About: Defendant Payless Shoesource, Inc. (“Payless”) leased space in plaintiff El Centro Mall, LLC’s (“ECM”) shopping center pursuant to a lease that expired December 31, 2005. The lease provided that Payless was to pay base rent, monthly percentage rent based on a percentage of Payless’ gross sales, and additional rent, which included all other costs such as common area maintenance and taxes. The lease required Payless to continuously operate and conduct business on the premises, and further provided that if Payless failed to continuously operate, the landlord was entitled to collect as liquidated damages (in addition to the base, percentage and additional rents) an additional charge of the greater of ten cents per square foot or $100 for each day of non-operation. The liquidated damages represented “the minimum damages which Landlord is deemed to have suffered, including damages as a result of Landlord’s failure to receive Percentage Rental, if any, under this Lease . . . .”

After closing its store in March 2005, Payless continued to pay the monthly base rent and additional rent through the end of the lease term (no percentage rent was owed), but refused to pay the liquidated damage amount. By stipulation, the trial court decided the case on briefs and stipulated facts, including alternative damage calculations depending on whether liquidated damages were recoverable. The trial court found that Payless did not overcome the presumption of validity of the liquidated damages clause and awarded plaintiff $90,226.80, which was the full amount of liquidated damages less a credit from reconciliation of CAM charges and taxes.

Court Holdings:

  • The court first discussed Civil Code section 1671, which provides that a liquidated damages clause is valid unless the challenging party establishes the provision was unreasonable under the circumstances existing at the time the contract was made. The burden of proof on the issue of reasonableness is on the party seeking to invalidate the liquidated damages provision.
  • The court held that to the extent the liquidated damages provision was intended to estimate damages for the tenant’s failure to pay percentage rent (as opposed to damages for loss of synergy, goodwill and patronage) during the period of non-operation, it was an unenforceable penalty. Because the lease separately provided the amount of percentage rent to be paid as damages if the lessor terminated the lease based on the tenant’s default, liquidated damages for failure to pay percentage rent were unnecessary except to penalize Payless.
  • With respect to damages for loss of synergy, goodwill and patronage, however, the court held that substantial evidence supported the trial court’s decision enforcing the liquidated damages provision, and that Payless failed to meet its burden of proving that the liquidated damages provision was unreasonable under the circumstances existing at the time the contract was made.
  • The court found that the evidence presented by Payless (i.e., that ECM allowed Sears, an anchor tenant, to vacate without paying liquidated damages, while other tenants who were not “national” tenants were required to pay liquidated damages) “may give rise to an inference the provision is arbitrary.”
  • However, the court found that the evidence did not “conclusively prove the point” because there was no evidence of the circumstances surrounding the other leases, such as whether there was another reason Sears was not required to pay liquidated damages or whether the other tenants (General Nutrition Corporation, Sports Image and The Locker) were or were not “national” tenants similar to Payless.
  • The court also noted that Payless failed to present evidence (e.g., expert testimony) that a charge of 10 cents per square foot was not a reasonable estimate of the actual damages the landlord would suffer if a tenant like Payless closed. In contrast, ECM presented an expert declaration stating that (1) in recognition of the fact that “national tenants” such as Payless generate significant foot traffic, landlords customarily require a covenant of continuous operation; (2) landlords also typically require a liquidated damage provision because it is difficult to estimate the damages from the loss of synergy, goodwill and patronage caused by a national tenant’s failure to continuously operate; and (3) the liquidated damage amount is directly proportional to the amount of space occupied by the tenant because larger stores are “likely to conduct more business, generate more goodwill to the retail center, generate more patronage to the retail center, generate more and better complimentary tenants at increased rents and also generate more percentage rent.”