Does Waiver of Right to Offset Rent Also Waive Tenant’s Right to Terminate for Landlord’s Material Default?
The right of a party to terminate a contract when the other party to the agreement commits a material breach is a fundamental principle of contract law. The black letter law: “A party’s continuing obligations under a contract are conditioned on there being no uncured material failure by the other party to render any such performance due at an earlier time” (Restatement (Second) of Contracts § 237).
The reason for this rule is simple: Parties must be able to count on the other side to perform before carrying out their own contractual obligations. This scenario, which is based on an actual case from the District of Columbia, illustrates the interaction between this termination right and other express provisions of a commercial lease governing a tenant’s remedies in the event of a landlord’s default.
THE LEASE
An 11-year lease covering two floors of commercial space in the heart of Chinatown requires the tenant to pay a $115,000 security deposit but also says that the landlord must refund one-third of the deposit, $38,000, after year 2, provided that the tenant isn’t in default at that time. The lease includes a No Rental Offset provision stating:
Except to the extent expressly provided in this Lease, in the event that at any time during the Lease Term Tenant shall have a claim against Landlord, Tenant shall not have the right to deduct the amount allegedly owed to Tenant from any rent or other sums payable to Landlord hereunder, it being understood that Tenant's sole method for recovering upon such claim shall be to institute an independent action against Landlord. . . . The obligation to pay rent under this Lease of Tenant is an express independent covenant of Tenant.
The lease also expressly allows the tenant to terminate unilaterally in two instances:
- A fire or other casualty requiring more than 12 months of restoration work occurs on the premises; or
- At the end of year 7, as long as the tenant isn’t in default and hasn’t assigned the lease to a third party.
In addition, the lease contains a “time is of the essence” clause.
SITUATION
Early into year 3 of the lease, the tenant sends the landlord a letter requesting the $38,000 security deposit refund to which it’s entitled. The landlord acknowledges receiving the request but doesn’t furnish the refund within 30 days as the lease requires. After 60 days of fruitless waiting, the tenant emails a default notice giving the landlord 30 days to cure the default by providing the refund. The landlord ignores the notice. So, after the 30 days have passed, the tenant notifies the landlord that it’s terminating the lease in response to the latter’s “material default.” The landlord claims that its failure to return the security deposit is only a “minor breach” and that the No Rental Offset clause bans the tenant from terminating the lease. The dispute lands in court.
QUESTION
Is the landlord’s failure to refund the security deposit grounds for the tenant to terminate the lease?
A. Yes, provided that the landlord’s failure to refund the security deposit really is a material default
B. No, because the No Rental Offset clause waives the tenant’s right to terminate even for a material default
C. Yes, regardless of whether the landlord’s breach was material or minor
D. No, because neither of the scenarios triggering the tenant’s unilateral termination rights under the lease occurred
ANSWER
A. The landlord’s breach of its obligation to refund the security deposit would be grounds for termination, provided that it constitutes a material default.
EXPLANATION
The landlord in this case didn’t contest the common law right of the tenant to terminate the lease early in the event of a material breach. Nor did it deny that its failure to refund the tenant’s security deposit constituted a breach of the lease. It merely contended that the breach wasn’t material, and thus not grounds for termination by the tenant. In the context of a lease agreement contemplating over $5 million in base rent over 11 years, the failure to refund a mere $38,000 was just a minor breach, the landlord argued. Of course, the tenant claimed that the breach was material, especially given that the COVID-19 pandemic was raging and that the lease included a time is of the essence clause.
The problem is that the lower court made a ruling on the case without considering this crucial issue. As a result, the appeals court reversed the decision and sent the case back down for a ruling on whether the landlord’s default was material. If so, the tenant would, in fact, have the right to terminate. So, A is the right answer [Hto7, LLC v. Elevate, LLC, 2024 D.C. App. LEXIS 285].
WHY WRONG ANSWERS ARE WRONG
B is wrong even though the lower court did rule that the No Rental Offset provision constituted a waiver of the tenant’s right to terminate in the event of a material default by the landlord. The appeals court said this ruling was wrong, noting that the No Rental Offset clause serves an entirely different purpose, namely, banning the tenant from resorting to just one particular type of self-help—withholding rent to offset damages. Thus, the tenant couldn’t collect the $38,000 it was owed by withholding rent and instead would have to sue the landlord for money damages.
However, the tenant in this case wasn’t seeking to collect the unrefunded security deposit but rather to end the lease completely. Terminating a lease due to a material breach “is an entirely different form of self-help that the No Rental Offset provision didn’t expressly or implicitly alter,” the court reasoned.
C is wrong because the question of whether the landlord’s breach in not providing the required security deposit refund is, in fact, crucial to the case. If the breach was material, early termination would be justified; and if the breach was minor, the tenant would still be obligated to pay rent and perform its other obligations under the lease.
D is wrong because the mere fact that the lease contains two other clauses expressly allowing the tenant to terminate early doesn’t mean these are the only grounds for early termination by the tenant. The right to leave after year 7 is just an opt out that has “no conceivable bearing on the tenant’s common law right to terminate” due to a landlord’s material default, according to the court. It would also be “bizarre” to read the “fire or other casualty” provision as being the only other basis for early termination by the tenant. Just imagine if the landlord had simply never given the tenant the keys but leased the premises to some other tenant instead. Of course, the tenant would have the right to terminate for material breach in these instances, notwithstanding that the breach didn’t involve “fire or other casualty.”
TAKEAWAY
A clause purporting to waive a tenant’s right to withhold rent or exercise any other particular remedy doesn’t strip the tenant of its common law right to terminate for a material breach by the landlord. While this right can be waived, the lease must clearly spell out that the tenant is waiving that particular right. But in the real world, it’s highly unlikely that any tenant or landlord would knowingly give up this crucial right. After all, the whole purpose of having a written lease to begin with is to ensure that both parties have a legal basis for trusting the other to keep its end of the deal before having to carry out their own obligations under the contract.
However, a waiver may be drafted narrowly to cover a particular kind of breach with the tenant acknowledging that such breach committed by the landlord (or vice versa) doesn’t constitute a material default triggering the right to terminate.
Early termination rights can also be waived by implication after the fact where one party commits a material breach and the other party knowingly and voluntarily lets it go. In refraining from exercising its right to terminate early, the party is effectively making the election to keep the lease intact and continue performing its duties under it even though the other party has committed a material default.