Performance and Breach of Leases - Module 8 of 8

Module 8: Performance and Breach

            In this module, we will look at the performance and breach of contract rules that apply to leases, including those of anticipatory breaches and substitute performance.

Anticipatory Repudiation

As in the case of a sale, a party who repudiates a lease agreement or states in advance that he will fail to perform has breached the agreement. The other party is free to behave as though the agreement will not be performed, to “cover” by seeking performance elsewhere and to sue for damages.

If a party reasonably believes that the other party to a lease will not perform, then the party reasonably suspecting non-performance may deem itself insecure. It should be noted that the party must have reasonable grounds before deeming itself insecure. For example, if the lessor declares bankruptcy or fails to deliver on similar contracts, that would be reasonable grounds for insecurity. Mere suspicion that the lessor might not perform would be insufficient.

The party may then make a written demand of adequate assurances of due performance from the other party.[1]  The insecure party may suspend any outstanding performance for which payment has not yet been received provided such suspension is commercially reasonable. Reasonable assurances may take the form of sending some of the goods to be leased or keeping the lease money in escrow.

If the other party does not provide the commercially reasonable assurances the insecure party has sought, or the other party indicates it will not perform, then the other party has effectively repudiated the lease under Article 2A.  The insecure party may then await retraction of the repudiation, make a demand for performance or seek damage remedies.

The offending party may retract its repudiation up until the insecure party’s cancellation of the lease.[2] However, a repudiation cannot be retracted once the other party has detrimentally relied on the retraction. For example, if the prospective lessee leases the goods from another source, the lessor can no longer retract the repudiation.

Substituted and Excused Performance

Sometimes performance may be substituted or excused.[3]  With respect to certain types of commercial and finance leases, once the lessee has accepted the goods, he incurs an irrevocable obligation to pay the rent due under the lease.  If the terms of the delivery of the goods, such as the location, means, or delivery of the goods fails through no fault of any of the parties, then a reasonable substitute delivery method must be tendered and accepted. It is difficult for the parties to be excused from performance because of extenuating circumstances. 

A mere delay does not normally constitute a breach of the lease.  In the event of a delay, the lessor must notify the lessee and, in a finance lease, the supplier must notify the lessor and lessee of any delay or non-performance.  A lessor must allocate what goods it does have on hand among its customers in the event of partial non-performance. One commentator recommends that when drafting a lease, one should disclaim any remedies involving substitute or excused performance.[4]

Lease Agreement Remedies

Article 2A provides rules and guidelines for the establishment of remedies.[5] However, the parties are free to determine what remedies will be available to the parties in the event of default, so long as the remedies do not disclaim the duties of good faith, diligence, reasonableness and care.  The parties may also not disclaim or waive the defense of unconscionability.[6] Courts often view excessive remedies as penalties and thus will not enforce them.

In an agreement, the parties may state that the contractually called-for remedies are exclusive, effectively eliminating any resort to remedies in Article 2A that are not part of the lease agreement.  The typical remedy in the case of defective goods is for the lessor to replace or repair the tendered goods.[7]  The parties may stipulate specific damages, called liquidated damages, which must be reasonable at the time of contracting.[8]  Liquidated damages may be set by a formula, but must not put one party in a superior position than she would have occupied had the lease been performed.  The parties may also stipulate, alter or even exclude consequential damages[9], which means tangential loss arising from the breach of the lease agreement (such as lost profits).  Such damages must not be unconscionable. Moreover, consequential damages are not recoverable for personal injuries incurred from the breach of a commercial lease.[10]

Remedies may be combined, such as repossession of the leased goods and monetary damages, as long as no party is put in a superior position to the position it would have occupied had the lease been performed.[11]  Notice of default is not ordinarily required before a party may pursue its legal remedies, but there are exceptions that apply exclusively to the lessee.[12] 

A lessee that rejects goods because of a defect must notify the lessor. If the lessee accepted the goods and then discovers a defect, he must notify the lessor within a reasonable time.  A lessor must also give notice if subject to a claim for infringement of intellectual property rights in a consumer lease.  Article 2A also contains protections that extend to consumer leases, such as special disclosure requirements, jurisdiction and venue rules and expanded unconscionability restrictions.[13]  Additionally, Article 2A provides for a four-year statute of limitations on lease actions that may be reduced by the parties to as little as one year.[14]

Remedies for Lessor’s Breach

The lessor is in breach if she fails to deliver conforming goods, repudiates the lease agreement, or breaches express or implied warranties.[15]  Absent a notice in the lease agreement the lessee may seek remedies without notice to the lessor.  A lessee may force the lessor to take back non-conforming goods or force the lessor to deliver the goods if they were not delivered.  The lessee may resort to the legal remedy of replevin or the equitable remedy of specific performance to recover the undelivered goods, though these are only available if monetary damages would be insufficient under the circumstances.[16] 

The lessee may “cover” by entering into a lease agreement “substantially similar” to the original lease agreement and obtain substitute goods.[17]  If the cover price forces the lessee to incur out-of-pocket costs, then the lessee may recover those costs as “incidental” damages from the defaulting lessor.  A lessee may alternatively use the market price of what would be a substitute lease when the lessee does not cover. 

In the case of a breach of warranty, the lessee may recover the difference between the value of the accepted goods and the value of the goods as warranted.[18]  A lessee may also cancel the lease when the lessor defaults.[19] A “hell or high-water lease” or a finance lease may prevent a lessee from cancelling a lease, even when the lessor is in default.

Remedies for Lessee’s Breach

When a lessee wrongfully rejects or revokes acceptance of the goods, repudiates the lease agreement or fails to make proper payment when due, she breaches the lease under Article 2A.[20]  The lessor has several remedies available.   A lessor may seek to repossess the goods from the lessee.[21]  The lessor may also enter into a “substantially similar” lease and recover any loss in damages represented by the difference in value between the breached lease and the substitute lease. As with the lessee, if the lessor does not qualify for a substitute lease transaction or is unable to lease the goods, then she may use the “market rent” to determine the damages necessary to give the lessor the benefit of his bargain. [22]

The lessor can seek a “lost-profit” damage measure when the market damage formula does not apply. For example, if the lessor is a car dealership and the lessee breaches a promise to lease a car, the lessor may recover whatever profits she’d have made off the lease. Note that the market value of the car or the cover price that could be recovered by leasing to another customer is irrelevant, because the dealer could lease substantially as many cars as there are customers. Therefore, the lost profit measure is the best way to measure the damages.

Additionally, the lessor may seek to recover the value of the rent for as long as the lessor does not repossess the goods or the lessor could not dispose of the goods.[23] If the goods are destroyed, the lessor may be able to recover the full value of the goods.

The lessor may also cancel the lease agreement in response to a lessee’s breach.[24]

Conclusion

            Thank you for participating in LawShelf’s video-course on sales and leases of goods. We hope this course has given you a strong background in the key provisions of Articles 2 and 2A of the UCC. Please let us know if you have any questions or feedback.