In the case of Austin Hill Country Realty, Inc., v. Palisades Plaza, Inc., the plaintiff Palisades Plaza, Inc., owned an office complex in Austin, Texas, and it rented office suites in the complex to various businesses. On September 15, 1992, Austin Hill Country Reality (Austin Hill) signed a five-year commercial office lease with Palisades for a suite in the complex. The lease called for the landlord (Palisades) to complete certain improvements in the space before the lease's November 15, 1992, start date. However, the tenant (Austin Hill) backed out of the contract before it began. Palisades sued Austin Hill for the value of the money already spent in improving the suite, and for the five years of rental payments stipulated by the lease. Austin Hill argued that their damages should be reduced by the amount of rent that Palisades could have received over the five year period if they had made a reasonable effort to finish the improvements and rent the property to another tenant. The trial court ruled that Austin Hill had to pay the full damages demanded by Palisades; in doing so it was following past Texas law. An appeals court reversed the ruling. Following the decisions of courts in other states, it established a new precedent for Texas, and held that Austin Hill’s damages should be reduced in the manner that Austin Hill requested. To be clear, this precedent means that when a commercial tenant breaks a lease, the landlord is entitled to the amount of unpaid rent that the tenant would have had to pay if he honored the lease and stayed in the rented space, minus the amount of rent the landlord could expected to get over the remaining term of the lease if he had made a reasonable attempt to rent the space to another tenant.
Commercial tenants like Austin Hill Country Realty face a lot of uncertainty that may lead them to break their leases with owners of the office buildings, malls, and so forth from which they rent space, including the risk that business might be bad at the leased location, or that they may simply not do as well financially as they thought they would for reasons unrelated to its location. Explain which party to a commercial lease transaction bore this risk under Texas law prior to the decision of the appeals court in the Austin Hill case, and address the following questions: Did the new precedent established by the appeals court shift any of this risk to the other party? Does it change the way that commercial landlords and/or tenants will behave in the future (that is, does in change their incentives)? If so, will these changes lead to higher lower social welfare (more or less wasteful behavior)? Finally, would the new precedent have any impact on the rents charged for commercial space in Texas?