Facts: Payless ShoeSource, Inc. ceased operations at a shopping center owned by El Centro Mall, LLC (ECM) before the end of its lease term. ECM charged Payless liquidated damages of 10 cents per square foot of its leased space for each day Payless did not operate, totaling $98,010. Payless refused to pay, alleging that the liquidated damages provision in its lease was an unenforceable penalty under California law. The trial court ruled in ECM’s favor, determining that the provision did not constitute an unlawful penalty.

On appeal, Payless contended that the liquidated damages provision setting damages at 10 cents per square foot was not a reasonable estimate of the potential damages of a future breach at the time the lease was signed. ECM argued that the provision was intended to reimburse it for the loss in “synergy, goodwill, and patronage the shopping center and other tenants would lose if Payless ceased operation.”

Decision: The appeals court upheld the trial court’s ruling in favor of the owner.

Reasoning: Under California law, there is a presumption of validity for liquidated damages clauses in a commercial context. In other words, a provision in a contract liquidating the damages for a breach of the contract is valid, unless the party seeking to invalidate the provision—in this case, Payless—shows that the provision was unreasonable “under the circumstances existing at the time the contract was made.”

Here, the appeals court ruled that while the provision was unenforceable to estimate percentage rental damages, other damages—including the anticipated loss of the synergy, goodwill, and patronage Payless provided by continuing to operate in the retail center—were enforceable. Retail centers such as ECM require a covenant of continuous operations from “national tenants” like Payless, which generate significant foot traffic in a retail center.

Because it is difficult to estimate the amount of damages from the loss of synergy, goodwill, and patronage when a “national tenant” such as Payless breaches a continuous operations covenant, the reasonable liquidated damage calculation is based upon the theory that the amount of business that a retail tenant may prospectively generate in patronage, synergy, or goodwill to the retail center, and in sales, is directly proportional to the amount of space occupied.

Payless failed to present evidence showing that a charge of 10 cents per square foot did not represent a reasonable estimate of the actual damages a retail center would suffer if a tenant like it ceased operations, and was in reality a penalty, so the provision was valid.

n El Centro Mall, LLC v. Payless ShoeSource, Inc., April 2009