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Sharply Divided Court of Appeals Upholds Waiver of Declaratory Relief by Commercial Tenants

In a closely watched appeal, the Court of Appeals affirmed by a 4-3 vote that a waiver contained in a commercial lease of the right to bring a declaratory judgment action is enforceable and not contrary to public policy.  The case, 159 MP Corp. v. Redbridge Bedford, LLC, No. 26, was not brought in the Commercial Division, but will have a significant impact on the drafting and enforcement of commercial leases.

The case involved two commercial leases signed in 2010 that allowed the tenant-plaintiffs to operate a Brooklyn supermarket.  The leases and various riders contained numerous handwritten edits that were initialed by the parties.  At issue in the case was a provision in the lease riders providing that: 1) the tenants (and only the tenants) waived the right to bring a declaratory judgement with respect to the lease or any notice sent pursuant to the lease, and 2) the parties intended that any disputes under the lease would be resolved through summary proceedings. 

In 2014, the defendant-landlord sent the plaintiffs a notice that they were in default under the leases and had 15 days to cure claimed violations in order to prevent termination of the leases.  The plaintiffs disputed the violations and brought the instant suit in Supreme Court, Kings County seeking: 1) a declaratory judgment that they were not in default of the leases, and 2) a Yellowstone injunction, which is a common remedy in commercial lease disputes to maintain the status quo by tolling the lease cure period so as to prevent the landlord from terminating the lease while the case is pending.  The defendants moved for summary judgment, arguing that the action (including the Yellowstone injunction) was barred by the waiver provisions in the leases.  The plaintiffs argued that, among other things, the waiver was unenforceable as it is against public policy.  Both Supreme Court and Appellate Division, Second Department, with one justice dissenting, ruled that the waiver was enforceable and thus required dismissal of plaintiffs’ claims.  Both courts emphasized that the waiver still left the plaintiffs with available legal remedies.

Writing for the majority of the Court of Appeals, Chief Judge Janet DiFiore affirmed the decision below.  The Court started by noting that the waiver clause was unambiguous and on its face precluded plaintiffs’ lawsuit.  The Court then turned to plaintiffs’ argument that the waiver should be set aside as against public policy.

Chief Judge DiFiore started her analysis with New York’s “deeply rooted” public policy in favor of freedom of contract, which is in keeping with “New York’s status as the preeminent commercial center in the United States” and promotes certainty and predictability.  For arm’s length transactions between sophisticated parties, freedom of contract requires enforcement of the parties’ agreed contractual terms absent public policy concerns.  The courts disfavor invalidating contractual provisions that the parties freely negotiated.  A contract clause may only be voided as against public policy (as embodied by the laws of New York) after balancing the public interests which favor invalidating the clause against the public interest in enforcing the terms agreed to by the parties.  The Court noted that the fact that a provision is merely contrary to public policy is insufficient to set it aside, as the courts regularly allow waivers of legal rights or benefits.  Only a limited number of public policy interests are “sufficiently fundamental to outweigh the public policy favoring freedom of contract.” 

The Court concluded that a waiver of declaratory relief, made in an unambiguous lease clause and adopted by sophisticated parties after arm’s length negotiations, does not violate the type of public policy interests that would require voiding the clause.  While declaratory relief is a “useful tool” that “benefits the parties as well as society in quieting disputes,” it is merely one form of relief for enforcing a contract.  The New York Legislature had neither expressly nor impliedly made such relief non-waivable.  Nor had the Court done so in its case law.  In upholding the waiver, the Court found it critical that it did not bar all access to the courts, that disputes could still be adjudicated through the summary proceedings allowed by the waiver clause, and that the parties could still seek tort or breach of contract damages.  In contrast, Chief Judge DiFiore noted that courts routinely enforce arbitration agreements, which are far more restrictive in terms of limiting parties’ access to the court system. 

That this particular waiver had the effect of barring the plaintiffs’ request for a Yellowstone injunction (because the underlying declaratory judgment action was barred by the waiver) did not alter the outcome.  The Court noted that a Yellowstone injunction merely preserves the status quo and is not an end in itself.  According to the Court, the plaintiffs would still be able to raise defenses against the purported defaults in any summary proceedings.  While Yellowstone injunctions are “useful procedural tools”, there is no strong societal interest in permitting them to be pursued in the context of commercial leases that is sufficient to void the unambiguous waiver clause.  Moreover, unlike the situation of residential tenants, the Legislature had not provided commercial tenants with a non-waivable post-adjudication cure period.

In a lengthy dissent, Judge Rowan Wilson took the position that the majority had made the Lochner-era mistake of treating freedom of contract as a personal right of the parties rather than focusing on the societal benefit from ensuring a degree of security and certainty in commercial transactions, which helps to maximize societal benefit through concepts like efficient breach.  By framing freedom of contract in this fashion, the question to Judge Wilson was not whether the lease waiver violated some separate public policy such that it outweighed the policy in favor of freedom of contract, but whether the waiver violated the public policy of freedom of contract itself.  According to Judge Wilson, declaratory relief is “an essential part of the policy of freedom of contract.”  Declaratory relief allows parties to conclusively clarify their rights and duties in a contract before a breach occurs, and allowing it to be waived violates the public policy in favor of freedom of contract by creating instability and uncertainty.  For the dissent, such waivers should therefore be unenforceable even if other judicial remedies remain available.  As to arbitration clauses, Judge Wilson noted that they had been unenforceable at common law, and that courts upheld such clauses only after the Legislature amended the common law to allow them.  The dissent also expressed concern over the practical outcome of the ruling, as waivers of declaratory relief (and the resulting unavailability of Yellowstone injunctions) will make it easier for landlords to terminate leases so that they can replace existing commercial tenants with ones willing to pay higher rents.

Whether waivers of declaratory relief will become commonplace in commercial leases remains to be seen, as does whether the Legislature will impose a non-waivable cure period in lieu of Yellowstone injunctions as it has done with residential leases (a legislative change that was called for by the dissent). It is also unclear how far these waivers will be extended.  For example, there may be non-default issues – such as whether a renewal option has been validly exercised – that could benefit from a declaratory ruling.  For now, however, the Court of Appeals has affirmed the ability of sophisticated parties’ to negotiate for such waivers in commercial leases and landlords will certainly be considering whether they can extract this concession in their lease negotiations.