does your lease contain unenforceable penalties?

Some residents violate their leases.  Over the years, we have seen many frustrated landlords attempt to coerce lease compliance by imposing penalties on residents for lease violations.  Types of penalties for lease violations are endless.  Some of the more common penalties are for having a pet, failing to pick up after a pet, making excessive noise, smoking, or violating parking restrictions.  For example, a typical lease penalty provides that the resident has to pay the landlord $100 if the resident smokes in his unit in violation of the lease.

Imposing penalties on residents for lease violations may seem like a good solution to force compliance and eliminate annoying and reoccurring problems.  However, your lease should not contain any penalties because penalties are not enforceable under Colorado law.  Many areas of the law are unclear, but the unenforceability of penalties is not one of them.  Since statehood, Colorado courts have consistently held that the law abhors forfeitures.  Because penalties are forfeitures, Colorado courts will not enforce any lease provision found to be a penalty.

Penalties are not enforceable, but liquidated damage provisions are enforceable.  However, the mere use of the words “liquidated damages” is not conclusive, and courts will scrutinize any liquidated damage lease provision to determine if it is a penalty.  In determining whether a provision is a valid liquidated damages provision or an unenforceable penalty, courts will look at three factors.  One, whether the parties intended to liquidate damages.  Two, at the time the lease is signed, whether the liquidated damages are reasonable estimate of your actual damages.  Three, at the time the lease is signed, whether it is difficult to ascertain the amount of actual damages that would result from a breach.  If  your lease fails to meet any of these tests, the provision is an unenforceable penalty.

Your probably thinking that your lease provisions easily meets these three tests.  However, analysis of the common penalty provision for noise illustrates that the analysis is more complicated than you think.  A typical provision provides that “Resident will be penalized (fined) $50 for excessive noise.”

In support of his case, the landlord would make the following arguments.  One, the resident signed the lease so the resident agreed that we “intended to liquidate damages”.  Two, if the resident makes excessive noise, the community is going to lose other residents, and a $50 fine is very reasonable compared to the lost revenue resulting from lost residents.  Three, if the resident makes noise, we don’t know how many residents will move out, so the communities actual damages are difficult to predict.  While these arguments sound good, the courts will not find them persuasive.

The landlord in our example has sunk his own boat by use of the word penalty.  If it looks like a duck, walks like a duck, and quacks like a duck, it is a duck.  If a lease provision uses the word penalty, the landlord’s intent is clear.  The provision is a “penalty”, and not a defensible liquidated damages provision.  Damage provisions are intended to make you whole in the event the resident breaches the lease.  Penalty provisions are intended to compel performance.  When the lease uses the word penalty and the penalty has no rationale relationship to actual damages, landlord’s intent is to compel performance of the lease rather than to provide a mechanism to determine damages for breach of the lease.

For those of you not convinced, let’s evaluate landlord’s position further.  Remember, landlord’s position is that the $50 noise penalty is reasonable (meets the 2nd test) because it pales in comparison to landlord’s actual losses if the noise persists (lost revenue from several residents who move out).  However, landlord’s logic is flawed because the test is whether the amount is a “reasonable estimate of landlord’s actual damages” at the time the lease is signed.  Landlord doesn’t know what his damages will be at the time the lease is signed if a resident makes excessive noise and drives off other residents.  However, landlord does know that his damages will be much greater than $50.  Therefore, the $50 penalty is not a reasonable estimate of landlord’s actual damages, and only further shows that the provision is intended to compel performance, and not to compensate for breach.  Accordingly, the $50 penalty is unenforceable.

Some clients may be thinking, “we impose penalties, and have never had a problem”.  If clients gave me a nickel for every time they told me that something was in their lease and they have never had a problem with it, the girls’ college education would be paid.  Just because you have never had a problem, doesn’t mean you won’t have one in the future.  If you have a penalty provision in  your lease, you are sitting on a keg of gun powder that eventually will be ignited.  Its not question of if, but when.

The fuse may be lit when you try to evict a tenant for not paying a penalty.  Specifically, you penalize the resident.  The resident doesn’t pay, and you attempt to evict the resident for failing to pay the penalty.  The court rules that your penalty provision is unenforceable.  You lose the case.  As the losing party, you have to pay the resident’s attorneys’ fees. Oh, did I mention that the resident hired Mr. Four Hundred A Hour as their attorney.  In attempting to collect your $50 noise penalty, you just got clocked for $5,000 in attorneys fees.  The resident broadcasts the results both in the building and on the internet.  Now you have multiple other residents taking shots at you.  If you decide not to enforce the penalty lease provision against residents who resist, you have just traded one problem for another.  Now you have a fair housing problem.

Under Colorado law, if residents are not complying with their lease, your remedy is to serve them with a demand for compliance or possession, not to penalize them.  For example, if the resident is making excessive noise, you serve a compliance demand that states “stop making excessive noise within three days or get out”.   Of course, some residents will make noise, and then fly right when you serve the demand, only to make noise later.  Fortunately, Colorado eviction law gives you the tools you need to deal with repeat offenders.  If a resident makes noise, flies right after service of a demand, and then makes noise again,  you can serve a three day notice to quit for a repeat violation, and the resident must vacate, or the court will evict them.  

Penalties are not enforceable.  Carefully thought out and well drafted liquidated damage clauses are enforceable.  Courts almost always will find any 

lease provision that uses the words “penalty” or “fine” is an unenforceable penalty. While the use of the word penalty will almost always sink you, the use of the expression “liquidated damages” won’t necessarily save you.  Because the law abhors a forfeiture, courts will heavily scrutinize liquidated damage provisions.  If your lease language is ambiguous, courts always construe the lease against you.  Liquidated damage provisions have their use but only in limited situations, and drafting a provision that meets the legal test is challenging.  Rather than attempting to be clever and trying to disguise a penalty as a liquidated damage provision, your much better off not having penalties, and enforcing your lease through the legal service of non-compliance demands.