Liquidated Damages in Residential Leases May Backfire

By: Stephen D. Richman, Senior Counsel - Kohrman, Jackson & Krantz

As you may know, Ohio’s Landlord-Tenant Act (Ohio Revised Code [O.R.C.] Chapter 5321) governs the relationship between landlord and tenant for residential property. As you may also know, there are many more tenant protections and landlord obligations for residential property (because of such Act) than for commercial property. For example, while often not advisable, a landlord in Ohio can utilize “self help” to evict a commercial tenant, provided there is no “breach of the peace” (See Northfield Park Associates v. Northeast Ohio Harness, 1987 Ohio App. LEXIS 10461 [8th Dist.]; Tie Bar v. Buffalo Mall, 1979 Ohio App. LEXIS 8786 [7th Dist.]; Carter v. Standard Oil Co. 1978 Ohio App. LEXIS 7861 [8th Dist.]). Pursuant to Ohio Revised Code Section 5321.15, however, a landlord of residential property may only use the court eviction process to recover possession from a defaulting tenant.

Security deposits (and the handling of same) are also treated differently. For example, landlords of residential (vs. commercial) property must pay interest on their tenants’ security deposits greater than $50 (pursuant to O.R.C. 5321.16(A)).

At the end of a lease, if a tenant owes its landlord rent (or has damaged the premises) the standard action of many landlords is to deduct whatever damages the Landlord has incurred and send to tenant any remainder.  When landlords of residential property take this approach, they must follow the procedures of O.R.C. 5321.16 (B), which provides that “Any deduction from the security deposit shall be itemized and identified by the landlord in a written notice delivered to the tenant together with the amount due, within thirty days after termination of the rental agreement and delivery of possession.” According to the Eighth District Court of Appeals in the recent case of Oldendick v Crocker, 2016-Ohio App.LEXIS-5621[8^th Dist.], however, residential landlords must be careful with what they deduct from their security deposits, or it may cost them more than their deduction.

The facts of the Oldendick case are as follows:

On September 10, 2013, Elisabeth Oldendick and her boyfriend (“Tenants” and “Appellants”) signed a one-year lease for a Cleveland Heights apartment owned by Mr. and Mrs. Crocker (“Landlords” and “Appellees”). The lease was to commence October 1, 2013 and end September 30, 2014 (the “lease” or the “lease agreement”). Under the lease, a monthly payment of $860 was due on the first day of each month and an $860 security deposit was also required. The lease also included an “early termination” provision, which required Tenants “to pay a fee of one month’s rent in addition to the regular rent until a tenant suitable to [landlord] executes a new lease term” if the Landlords agreed to an early termination (of the lease) request by the Tenants. Three days after Tenants signed the lease, they told Landlords they had changed their minds, and demanded the return of the $1,720 paid when they signed the lease. After just eight showings, and one month later, the Landlords were able to lease the apartment to a new tenant, whose lease commenced on November 1, 2013. The Landlords paid a manager $120 for her time in showing the apartment to the prospective new tenants and an additional $100 in commission for the newly executed lease. The Landlords refused to return the funds Tenants had paid them because they had been unable to re-rent the apartment until November 1, 2013 and, in their opinion, according to the terms of the lease, Tenants were responsible for the October rent and an early termination fee of one month’s rent. 

                

In November, 2013, Tenants filed a complaint in the Cleveland Heights Municipal Court (“trial court”) against Landlords seeking to recover (1) the $1,720 paid for the first month’s rent and security deposit, (2) “an equal amount as damages” and (3) attorney fees and costs. Tenants also sought to declare the entire lease void, claiming the early termination fee provision was an unconscionable liquidated damages clause which rendered the entire lease unenforceable.

On July 10, 2015, the trial court issued its decision, finding in favor of Appellees. The trial court determined that Tenants had entered into a valid lease and that the parties were “at that point bound by the terms and conditions of the lease agreement.” The trial court further held that the Tenants had breached the lease agreement by repudiating the lease and refusing to take possession of the premises. The trial court then concluded that the early termination provision was enforceable, that it was not an unconscionable penalty and that, as a result of Tenants’ breach of the lease, Landlords were entitled to keep the $1,720 they received from Tenants as the October, 2013 rent and the early termination fee. Some time thereafter, the Tenants then appealed the trial court’s decision to the 8^th District Court of Appeals.

At the court of appeals, the Tenants first contended that the trial court should have declared the entire lease unenforceable under O.R.C. 5321.14 because the lease included a provision authorizing the payment of the Landlords’ attorney fees and various self-help provisions.  The court of appeals, however did not find this argument persuasive, largely because the trial court did not award Appellees any attorney fees and because there was no claim that Appellees exercised any of the self-help remedies that Tenants objected to. Even assuming those provisions of the lease were invalid, the appellate court found no error by the trial court in refusing to declare the entire lease unenforceable, because under O.R.C. 5321.14(A), a court “may refuse to enforce the rental agreement or it may enforce the remainder of the rental agreement without the unconscionable clause, or it may so limit the application of any unconscionable clause as to avoid any unconscionable result.”

Expectedly, Appellants further contended that “even if the lease was not unenforceable in its entirety, at the very least the trial court should have found the early termination provision to be unconscionable and refused to enforce it under R.C. 5321.14(A) and R.C. 5321.16(B).”

Appellees argued that the early termination fee was enforceable because courts have upheld liquidated damages clauses where actual damages may be difficult to prove, the amount of damages is reasonable and proportional to the contract as a whole, and that in this case, the Landlords and Tenants were parties of “equal bargaining power” who “agreed to and freely negotiated” the early termination provision.

Regarding enforceability of the liquidated damages provision, the court of appeals in Oldendick acknowledged Appellants’ argument that (while Chapter 5321 does not specifically prohibit liquidated damages clauses) there are indeed many Ohio courts that have declared such provisions unenforceable in a residential lease. The court in Oldendick stated that some of these courts have performed a penalty analysis in determining whether a fixed fee or charge set forth in a lease could be enforceable, refusing to enforce the same where the landlord failed to present evidence demonstrating that stipulated damages bore a reasonable relationship to actual damages sustained as a result of the breach. Other cases, according to the court have held that a liquidated damages clause in effect permits the landlord to retain a security deposit without itemization of actual damages, and this is inconsistent with O.R.C. 5321.16 (B), which requires itemization of damages. If the liquidated damages provision is inconsistent with O.R.C. 5231.16 (B), these courts have held that such provision may not be included in a rental agreement and is thus not enforceable.

The Court in Oldendick related more with the “inconsistent with O.R.C. 5321.16 and thus unenforceable decisions” (than to the “unenforceable as penalty decisions”), but seemed to want to simplify the analysis of these cases even further by not focusing on enforceability. According to the court in Oldendick, “the issue here is not whether liquidated damages provisions in residential leases are enforceable. The issue here is what a landlord is statutorily permitted to do, under the Landlord-Tenant Act, with a tenant’s security deposit. If deductions from a security deposit are at issue, the provisions of the Landlord-Tenant Act apply, which limits permissible deductions from a security deposit to ‘damages that the landlord has suffered by reason of the tenant’s noncompliance with section 5321.05 of the Revised Code or the rental agreement,’ i.e., actual damages sustained by the landlord as a tenant’s failure to comply with R.C. 5321.05 or the lease.”  

The Oldendick court cited other Ohio appellate courts that came to this same, “simplified” conclusion. ‘See, e.g., Ankney v. Dame, 6th Dist. Lucas No. L-76-307, 1977 Ohio App. LEXIS 10154, *5-8 (Apr. 29, 1977) (“It is not so much a matter of saying that liquidated damages are prohibited in leases, but the issue is whether the deposit put up herein is covered by the Act. * * * Any actual damages are permitted to be obtained by the landlord from the security deposit. * * * [T]he parties may contract for liquidated damages. However, if a deposit is required, then the provisions of the Landlord-Tenant Act must be followed.”)’

Because there was nothing in the record that established that the parties were of “equal bargaining power” and that as a general rule, damages resulting from a breach of a residential lease are not difficult to ascertain and quantify,  the court in Oldendick concluded that “even if we were required to perform a liquidated damages-penalty analysis to determine the appropriateness of Crocker’s deductions from Oldendick’s security deposit, we would find that the early termination fee operated as a penalty.”

So, according to the court in Oldendick, whatever way you look at it, the Landlords were not entitled to deduct the early termination fee from the Tenants’ security deposit. Landlord was, however entitled to deduct the $220 paid to the property manager as legitimate, itemized expenses. The court then concluded that pursuant to O.R.C. 5321.16 (B), the Landlords would need to remit $640.00 to the Tenant (the amount wrongly withheld, over and above the legitimate deductions).

Unfortunately for the Landlords, O.R.C. 5321.16 would prove more costly than remitting to Tenants the $640 worth of liquidated damages wrongfully withheld. While O.R.C. 5321 (B) deals only with what a landlord is obligated to do regarding the deduction of items from a security deposit, O.R.C. 5321.16 (C) deals with what tenants are permitted to claim as a result of their landlords failing to comply with O.R.C. 5321.16 (B).

O.R.C. 5321.16 (C) provides, in pertinent part, “If the landlord fails to comply with division (B) of this section, the tenant may recover the property and money due him, together with damages in an amount equal to the amount wrongfully withheld, and reasonable attorneys’ fees.” The Tenants in Oldendick in fact did make O.R.C. 5321.16 (C) claims, and the court awarded the Tenants damages of $640 and attorneys’ fees, on top of the $640 wrongfully withheld by the Landlords.

What is the moral of this story? For residential landlords, the expression “penny wise but pound foolish” comes to mind. While liquidated damages provisions are not per se prohibited in residential leases, the inclusion of same simply is not worth it because of the Ohio Landlord-Tenant Act, specifically, Ohio Revised Code Sections 5321.14 and 5321.16.