1250 Broadway, 27th Floor New York, NY 10001


In 1997, Bates Advertising entered into a sixteen-year lease with its landlord, 498 Seventh, LLC, for 25% of the building located at 498 Seventh Avenue in Manhattan. The 85-page lease, which provided for a base rent totaling some $100 million over the entire tenancy term, addressed "Landlord's Work," and provided a list of eleven "required alterations." Pursuant to that agreement, if the landlord failed to "substantially complete" nine of those 11 items, the tenant would be entitled to abatement of one-half day's rent for each day's delay, and, a full day's abatement for the remaining two items (one of which was the installation of a "Class E fire alarm and communications system").
In 1999, Bates moved into the space and commenced paying rent--after an initial, previously negotiated rent-free period--subject to its rights under the lease's rent-abatement clause. Alleging that the required work remained unfinished, Bates subsequently filed suit in the New York County Supreme Court asserting that it had been denied the "benefit of its bargain," in that it did not receive "top-shelf commercial accommodations" as originally contemplated and that the premises' condition presented a "safety and security" threat to company employees and adversely impacted the company's "image in the international advertising and marketing industry."
The Supreme Court partially dismissed the advertising company's case, believing the rent-abatement clause was an "unenforceable penalty," but allowed Bates to pursue other contract-related damages. On appeal, the Appellate Division, First Department, reversed. Although it felt the Bates would have difficulty proving its "image" and business damages, the Appellate Division reinstated the rent-abatement claim since it was a "vital part of the deal," and sent the matter back for further review and determination by the trial court.
After a bench trial, the Supreme Court concluded the landlord had failed to provide the necessary fire alarm and communications systems for some 412 days and awarded the tenant a rent credit of $4,339,528.61. On appeal, the Appellate Division affirmed the award. As did the New York State Court of Appeals.
While the tenant's representative had testified that the rent-abatement clause had been negotiated as a means of "incentivizing" the landlord and served as a "club over [the landlord's] head to make sure...the work [got] done," the Court of Appeals refused to characterize the provision as an "illegitimate and unenforceable" penalty, noting as follows:

[T]he prospect of damages in the event of breach may always be said to encourage parties to comply with their contractual obligations. Liquidated damages are not transformed into a penalty merely because they operate in this way as well, so long as they are not grossly out of scale with foreseeable losses. In this case, we agree with the Appellate Division that 498 has not demonstrated that the rent abatements are conspicuously disproportionate to Bates's foreseeable losses.
This case leaves us with a number of unanswered questions. Chief among them is whether the $4.3M adjustment was entirely appropriate given the absence of a fire-related incident or the issuance any fines or penalties issued by a governmental authority. What were the "losses" suffered by the tenant?
Since the decision is conspicuously silent as to the actual amount of the tenant's "losses" and how that sum correlated with the mult-million dollar award the tenant received, we are unable to discern whether or not the case's outcome resulted in a "windfall" to the tenant.
Most unfortunate, don't you think?
For a copy of the Court's decision, please click on the following link: