Property Leasing

Special acknowledgement and thanks to Nusrat Ali, Student-at-Law, for her valuable assistance in preparing this article.

ALLOCATION OF RISK UPDATE:  INTERPLAY OF INSURANCE, INDEMNITY & RELEASE CLAUSES

Any analysis with respect to the allocation of risk in a commercial lease will inevitably draw upon the principles set out by the Supreme Court of Canada in the “Trilogy”: (1) Pyrotech Products Ltd. v. Ross Southward Tire Ltd., (1975) [1976] 2 S.C.R. 35; (2) Cummer-Yonge Investments Ltd. v. Agnew-Surpass Shoe Stores Ltd., (1975) [1976] 2 S.C.R. 221; and (3) Smith v. T. Eaton Co., (1977) [1978] 2 S.C.R. 749. Each of these Trilogy cases involved attempts by a landlord (or its insurer by way of subrogation) to recover damages from a tenant as a result of fire damage caused by each tenant’s negligence. In all three cases, the Supreme Court found in favor of the tenant and dismissed each landlord’s action on the basis of the principle of immunity. The Supreme Court established the principles that in a landlord-tenant relationship where there is an express obligation by one party to obtain property insurance or an express obligation by the tenant to contribute to the costs of insurance, each operates as an assumption of risk for loss or damage caused by the other party, including for acts of negligence. Canadian Courts continue to rely on the Trilogy principles in dismissing actions brought by innocent parties (or their insurers) against negligent parties, suggesting that only the most clear, express and unambiguous language will provide an exception to the principle of immunity.

In Deslaurier Custom Cabinets Inc. 2017 ONCA 293, (leave to appeal to SCC refused), 2017 CanLII 68350, the tenant leased several units in the landlord’s commercial building. On January 1, 2009, a fire occurred due to repairs that were being made by the landlord’s contractors, causing significant damages to the building including the tenant’s premises and its property. The building was a total loss and was eventually demolished. The tenant made a claim to its insurer but the amount it received was insufficient to fully cover its losses. The tenant brought an action against the landlord to recover costs for its uninsured property and the tenant’s insurer sought recovery of the subrogated loss. The landlord defended on the basis that: (1) the tenant assumed the risk of loss; and (2) if the tenant had added the landlord as an additional insured to its policy as required by the lease, the tenant and its insurer would be precluded from claiming against the landlord.

The motion judge held that the landlord’s indemnity took priority over the tenant’s obligation to insure – meaning, the landlord had assumed responsibility to indemnify the tenant in respect of any damage to its property and business caused by the landlord’s actions or actions of its agents and contractors. The Ontario Court of Appeal rejected the motion judge’s interpretation of the lease and decision. Instead, the Court found that the tenant’s obligation to insure against all risk of loss or damage to its own property caused by fire relieved the landlord from liability. In addition, the Court held that the tenant’s insurer should not be able to bring a subrogated claim against the landlord because it would not have been able to bring such a claim if the tenant had complied with its obligations under the lease to name the landlord as an additional insured.

While the tenant’s application for leave to appeal this decision was pending, the Supreme Court of Canada directed the Court of Appeal to reconsider its decision in light of the Supreme Court’s ruling in Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., 2016 SCC 37. The Court of Appeal did so, but noted that the Ledcor principles regarding standard form contracts would not apply to this case as the lease in question was a negotiated contract and therefore, the standard of review applied in its previous decision was correct. Once again, the tenant sought leave to appeal, but on October 9, 2017, the SCC provided finality by dismissing the tenant’s application for leave. By refusing leave to appeal, the Supreme Court inferentially affirmed the precedential value of the Trilogy principles and that only in the clearest of cases will it be possible to rebut the principle of immunity.

But just when all hope seemed lost for landlord-insurers, the Ontario Court of Appeal threw them a life-line with Royal Host v. 1842259 Ontario Ltd., 2018 ONCA 467.

In Royal Host, the tenant leased premises to operate a restaurant. A fire in the tenant’s restaurant kitchen caused damage to the building. The damage was covered by the fire insurance covenanted by the landlord to be taken out under the lease, for which the tenant contributed to premiums. The insurer indemnified the landlord but brought a claim against the tenant through its right of subrogation. Relying on the Trilogy principles, the trial judge held that the insurer’s claim was barred on the basis that when a landlord covenants to obtain insurance for fire damage, the landlord is barred from recovering losses from the tenant absent clear, express or unambiguous language in the lease stating otherwise.

However, the Ontario Court of Appeal found that the motion judge erred in his interpretation of the lease and the application of the Trilogy principles on the basis that there was clear, unambiguous and sufficient language that rebuts the principle of immunity. In Royal Host, the tenant’s indemnity clause included “notwithstanding” language which explicitly states that “the tenant remain[ed] liable for its own negligence notwithstanding the landlord’s covenant to purchase insurance and the tenant’s contribution for the cost of that insurance.” As a result, a subrogation claim in relation to the exception clause would not have been contrary to the parties’ intentions and the insurer could bring a subrogated claim for damages. The Court of Appeal found this language sufficient to allow the landlord’s insurer to bring a claim against the tenant (note: the Court did not rule that the tenant was negligent and was responsible for the loss, but rather that the landlord’s insurer was not precluded from bringing a claim for same).

Although we would not call the decision in Royal Host surprising given the express language in question, it is interesting to see our Courts opening this window for insurers given all the previous case law and general reluctance to do so in the past.  We now have a small handful of cases, including Royal Host and Lee-Mar Developments Ltd. v. Monto Industries Ltd. [2000] O.T.C. 250 (Ont Sup Ct J), affirmed (2001), 146 O.A.C. 360 (CA), which illustrate that it is possible to contract out of the Trilogy principles.

SUBTENANT’S SECURITY OF TENURE FOLLOWING ABANDONMENT BY TENANT

What security of tenure does a subtenant have? Subject to a subtenant’s statutory rights (discussed below), in the event the head lease is cancelled, terminated or surrendered, the subtenant cannot force a head landlord to recognize its tenancy or allow it to remain in possession of the subleased premises unless there is privity of contract between the landlord and the subtenant (e.g., non-disturbance agreement or tri-party consent to sublease), and the contract in question provides non-disturbance comfort.

In the Province of Ontario, subtenants enjoy statutory rights pursuant to the Commercial Tenancies Act (Ontario), R.S.O. 1990, c. L.7 (“CTA”): Section 17 (Surrender of Lease); Section 21 (Termination of Lease and Relief of Forfeiture); and Section 39(2) (Bankruptcy of Tenant). In particular, Section 17 provides that if the lease is surrendered, the subtenant becomes the tenant of the landlord under the terms of the sublease. In other words, the landlord steps into the shoes of the sublandlord (the tenant) and accepts the sublease as if it had entered into it directly with the subtenant.

In Smiles First Corporation v. 2377087 Ontario Ltd., 2018 ONCA 524, the Ontario Court of Appeal grappled with the issue of whether a landlord’s acceptance of rent from the applicant, who claimed to be an assignee, amounted to a recognition of an equitable assignment. The Court also ruled on the impact a lease abandonment has on a subsisting sublease.

On January 12, 2015, the landlord entered into a lease with the tenant. The tenant then subleased the premises to the applicant subtenant (Smiles First). Under the sublease, the subtenant agreed to pay a significantly higher rent than the tenant was paying to the landlord under the head lease.

Disputes later arose between the parties under both the head lease and the sublease. On October 31, 2016, the parties to the sublease executed an assignment of the head lease to the subtenant, but without the head landlord’s consent. In November 2016, the head landlord proposed a settlement agreement to the tenant and subtenant which, among other things, required the tenant to vacate the premises. The tenant signed the agreement and abandoned the premises as of November 1, 2016. The subtenant did not execute the settlement agreement but began paying rent in November 2016, which was accepted by the landlord.

Not surprisingly, Smiles First argued that it was the “official tenant” under the head lease by virtue of the executed assignment, and in the alternative, even if the assignment was invalid, that the head lease was equitably assigned once the landlord accepted rent from Smiles First after the head tenant abandoned the premises. However, the landlord took the position that the applicant was a month-to-month occupant (and not an assignee) under the lease. Soon after, the landlord provided the applicant with a notice of termination of the monthly tenancy. The applicant (Smiles First) sought a declaration that the assignment (as between tenant and subtenant) was binding and an order for relief from forfeiture.

The application judge found that the assignment was not legally effective because the landlord’s consent, as required by the terms of the assignment clause in the head lease, was not obtained. As well, the head lease only allowed the tenant to assign its rights to the lease if it was not in default, but in this case, the tenant was in arrears of rent.

The application judge also found that the landlord’s acceptance of the rent during the time when the parties were engaged in settlement negotiations was not an indication of the landlord’s intention to treat the proposed assignment as valid. Moreover, neither the landlord’s acceptance of rent nor its willingness to allow the proposed assignee to remain in possession of the premises automatically results in an equitable assignment of the lease. The application judge further held that the acceptance of rent did not constitute a waiver or estop the landlord from asserting its rights under the lease.

The applicant appealed the decision but the Ontario Court of Appeal held that there was no reversible error in the application judge’s analysis of the issues regarding the assignment, or lack thereof, of the lease. Although the Court found the applications judge was correct in finding that the tenant had abandoned the head lease as part of its settlement with the landlord, the Court held that the judge had erred in accepting the landlord’s argument that the surrender of the head lease resulted in termination of the sublease and the judge’s finding that Smiles First was not a subtenant. However, the application judge had properly refused Smiles First’s request for a declaration that pursuant to the sublease it was entitled to remain in the premises “on the same terms and conditions as the Head Lease.” The Court explained the law on this area is well settled (citing case law and Section 17 of CTA) and that when a head lease is surrendered, the sublease survives and the subtenant is entitled to possession of the premises “under the terms of the Sublease.” Accordingly, Smiles First was entitled to relief against the landlord’s attempt to terminate its possession of the premises (on the basis that it was merely a monthly tenant) and the termination notice was of no force or effect.

What makes the Smiles First case especially interesting is that a subtenant who attempted to take an unlawful assignment of the head lease was still entitled to relief from forfeiture as a subtenant.

FORMATION OF CONTRACT & FUNDAMENTAL BREACH

In Northridge Property Management Inc. v. Champion Products Corp., 2017 ONCA 249, the Court considered two issues relating to agreements to lease: (i) when an agreement to lease is binding, as opposed to an unenforceable “agreement to agree”; and (ii) when the threshold of a fundamental breach by the landlord is achieved.

Before discussing the decision in Northridge, let us go back to basics. The case law is well settled – there are certain essential terms that must be agreed upon by the parties in order for a court to find there is a binding and enforceable lease agreement in place. The essential elements of a lease (as set out by Williams & Rhodes, and approved in many cases) are: “the parties, a description of the premises to be demised, the commencement date and duration of the term, the rent, if any, and all material terms of the contract not incident to the relation of landlord and tenant.”

With respect to fundamental breach, contract law recognizes that when there has been a fundamental breach, the wronged party may terminate the contract and claim damages. Historically, fundamental breach was a difficult case to make in the commercial leasing context, but since the late 1980s there have been a handful of cases where tenants argued successfully that the landlord’s breach was a fundamental breach and the tenants were entitled to treat the lease as at an end.

In Northridge, the landlord and tenant entered into an offer to lease for the tenant to operate a party supply business and a sanitation supply business in the premises. The offer outlined a list of renovations that the landlord was required to complete prior to or within the first month of the tenant’s possession of the premises. The landlord did not complete the renovations and the tenant subsequently abandoned the premises on the basis that the premises were zoned for warehouse use and not retail (and therefore, unsuitable for the tenant’s business). The landlord brought an action against the tenant for damages for breach of lease. The tenant argued there was no binding lease between the landlord and tenant and that the offer was a mere agreement to agree. In the alternative, the tenant argued that the landlord had fundamentally breached the lease.

The trial judge held that the offer to lease was binding because both the landlord and the tenant had carefully discussed the terms of the offer. In affirming the trial judge’s decision, the Ontario Court of Appeal also noted that the parties were sophisticated corporate entities that negotiated the terms of the offer, committed those terms to writing and signed a document reflecting those terms. In addition, the Court found that the language and dispute resolution mechanisms contained in the offer represented the characteristics and fulfilled all the requirements of a valid lease. Northridge serves as a reminder for both landlords and tenants that offers to lease can create valid and enforceable obligations and therefore it is imperative for parties to ensure that their interests are properly reflected in such offers.

With respect to the fundamental breach issue, Northridge demonstrates that fundamental breach is a high standard to meet. The trial judge declined to find that the landlord had fundamentally breached the offer to lease and the Court of Appeal agreed. In respect of the zoning argument, the court found the zoning was suitable as the tenant’s business was chiefly a warehouse and the first time the zoning issue was raised was in defense to this action. As for the outstanding renovation work, the judge found the deficiencies could be remedied for approximately C$25,000, which was relatively insignificant in relation to the value of the lease. The Court noted that the landlord’s failure to perform the repairs did not deprive the tenant of essentially the whole benefit of the agreement to lease.

OPTION TO RENEW: WAIVING STRICT COMPLIANCE BY CONDUCT – LANDLORDS BEWARE OF HOW YOU ACT

The decision in L’Ouvrier Inc. v. Leung, 2017 ONCA 589, acts as a warning to landlords to be careful about how they act following a casual or informal discussion about lease renewals with tenants. When a landlord waives its right to strict compliance with the lease, either explicitly or by its conduct, the terms of the lease no longer protect that landlord.

In this case, the dispute pertained to the tenant’s right to renew its 5-year lease. The lease contained an option to renew for two additional 5-year terms. The tenant could only renew if it provided the landlord with prior written notice and if it was not in default of the lease. Prior to expiry, the tenant approached the landlord to renew the lease. The landlord informed the tenant that it had lost its option to renew because it was in arrears of additional rent. The landlord, however, advised the tenant that it would allow a renewal if the renewal rent was double the basic rent of the original lease.

The tenant brought an application for summary judgement to enforce the terms of the lease. Although the landlord and tenant agreed to settle before the tenant’s motion, the settlement failed when the landlord demanded additional payments. The landlord refused to participate in the arbitration and locked the tenant out of the premises. The tenant brought a motion for summary judgment to enforce the terms of the contract.

The motion judge held that the landlord was in breach and that the tenant had properly exercised its right to renew the lease. In coming to its decision, the motion judge relied on the decision of Director’s Film Co. v. Vinifera Wine Services Inc., (1998), 1998 Carswell Ont 977. In that decision, the judge held that a tenant’s casual or informal communication of its desire to renew can constitute a valid exercise of its option to renew if the landlord, by its conduct, waives its right to strict compliance with the terms of the lease. In this case, the motion judge found that the tenant’s text message to the landlord served as sufficient written notice to exercise its renewal option. The Court pointed out that following delivery of the text message, the parties acted in a manner consistent with the notice having been properly provided. As well, the Court held that the landlord’s demand for additional rent was not authorized by the lease. The lower court granted the summary judgement and ordered the landlord to pay damages in excess of C$140,000 to the tenant for loss of the ability to sell its business. The Court also granted punitive damages of C$20,000 for the “sufficiently egregious” actions of the landlord. The landlord’s conduct following the text message also showed that the tenant’s notice was properly provided. The landlord appealed the judgment on the basis of administrative fairness issues. The Court of Appeal dismissed the appeal.

The North Elgin Centre Inc. v. McDonald’s Restaurants of Canada Ltd., 2018 ONCA 71 decision provides additional clarity with regard to situations where a landlord who has waived its right to strict compliance wishes to reinforce those rights. In this case, although the tenant gave proper notice to renew, the parties failed to agree on a rent for the renewal period nine months prior to the expiration date. Following this, the landlord applied for a declaration that the lease would terminate on March 20, 2017. The tenant applied for a declaration that the lease had been renewed and that parties should proceed to arbitration to establish a fair market rental rate.

The application judge held that the renewal provisions required the tenant to do more than simply provide notice. As a result, the application judge granted the landlord’s orders and dismissed the plaintiff’s application. On appeal by the tenant, however, the Court of Appeal set aside the application judge’s orders and declared that the lease had been renewed and that the parties should proceed to arbitration to determine the fair market rental rate for the premises.

The Court noted that there was no error in the application judge’s conclusion that the landlord waived strict compliance with the renewal provisions under the lease. However, the application judge erred in finding that the waiver was subsequently revoked by an email sent by the landlord to the tenant in 2016. The Court held that for a waiver to be revoked, the receiving party must receive reasonable and clear notice that the party who granted the waiver will now insist upon the strict enforcement of its legal rights. In addition, the notice must also provide the receiving party with an opportunity to cure any defect resulting from its reliance on the waiver. In this case, the Court found that the 2016 email did not clearly indicate that the landlord would be asserting strict enforcement of its legal rights. The email also did not provide the tenant with a reasonable period to cure the breach of the lease.

Both L’Ouvrier Inc. and North Elgin Centre Inc. emphasize the importance of the parties’ conduct in relation to renewing leases. If a landlord does not want to waive its rights to strict compliance, the landlord must act carefully and be mindful of how its actions may be perceived by the tenant or a court in the context of a dispute. If a landlord wants to reinstate its waived rights, the landlord must provide sufficient and reasonable notice for the tenant to cure the breach of the lease.

RELIEF FROM FORFEITURE: NOT AVAILABLE IF TENANT’S BREACH IS NOT “TECHNICAL”

In Wittington Properties Ltd. v. Goodlife Fitness Centres Inc., 2017 ONSC 1426, the tenant entered into a lease to operate a fitness club. According to the lease, if the tenant was not in default, it had an option to extend the lease for an additional 5-year term. In 2014, however, the landlord informed the tenant that it had lost its right to extend the lease due to ongoing breaches.

The landlord brought an application against the tenant to seek an order that (1) the tenant had lost its right to extend the lease, (2) the tenant had lost its entitlements to exercise a further option to extend, (3) the lease would expire on February 28, 2017, (4) the tenant would be required to deliver vacant possession of the premises on or before the expiry date, and (5) there would be leave to issue a writ of possession after March 1, 2017. In response, the tenant brought an application for a declaration that (1) the lease was in full force and effect, (2) the tenant validly exercised its option to extend the lease, and (3) the landlord must provide possession of the premises to the tenant for the extension period. In the alternative, the tenant applied for an order for relief from forfeiture.

With respect to the tenant’s application for relief from forfeiture, the Court assessed the tenant’s diligence in complying with the terms of the lease and landlord’s financial losses. The tenant argued that its breach of the lease amounted to a technical breach that did not result in any financial loss for the landlord. The tenant also submitted that the technical breaches were examples of situations where the courts should exercise their discretion and grant relief from forfeiture.

In the end, the Court granted the landlord’s order and declared that the tenant had no right to extend the lease (as the tenant’s breaches were not merely technical) and that the tenant must deliver vacant possession on or before February 28, 2017.

Although this case reiterates the limited scope of granting relief from forfeiture, it follows previous case law to confirm that in event of a technical breach, courts have the discretionary power to grant such relief.

REPUDIATION OF LEASE BY TENANT – LANDLORD’S OPTIONS?

In Highway Properties Ltd. v. Kelly Douglas & Co., (1971) SCR 562 (SCC), the Supreme Court identified four mutually exclusive courses of action open to landlords when a tenant repudiates a lease: (1) do nothing to alter the tenancy relationship but insist on performance of the terms and sue for outstanding rent or damages; (2) elect to terminate the lease but retain the right to sue for outstanding rent or damages; (3) advise the tenant that the landlord proposes to re-let the property as an agent of the tenant and enter into possession; and (4) elect to terminate the lease but with notice to the tenant that damages will be claimed for future damages (on a present value basis) for losing the benefit of the lease over its unexpired term.

In a recent case, Stearman v. Powers, 2017 BCCA 165, the Court considered: (a) was the lease terminated? and (b) had the landlord provided the tenant with clear and unequivocal notice of its intention to insist on the tenant’s obligations to pay rent?

In this case, the tenant entered into a 5-year lease to operate a retail clothing business in 2008. During the following year, the tenant complained of a strong odour that was interfering with her business. By November 2009, the tenant stopped paying rent and vacated the premises. The landlord brought an action for arrears of rent against the tenant and the tenant counterclaimed for damages arising from breach of the landlord’s covenant of quiet enjoyment.

At the first trial, the judge held that the landlord’s failure to eliminate the odour constituted a fundamental breach of the lease. The landlord’s claim was dismissed and the tenant was awarded damages. On the first appeal, however, the Court of Appeal set aside the trial judge’s decision and referred the landlord’s claim to the British Columbia Supreme Court for retrial of the claim for damages. The BC Supreme Court held that the landlord failed to provide the tenant with a clear notice of its intention to hold the tenant accountable for the rent during the remaining term of the lease and that the lease was terminated as a result of the landlord’s conduct after the tenant vacated the premises.

The landlord relied on Highway Properties Ltd. to again appeal the decision by claiming that the lease was never terminated. The landlord argued that it acted as an agent of the tenant to re-let the property. The Court of Appeal accepted the BC Supreme Court’s reasoning and held that the landlord’s conduct as a whole was consistent with an intention to terminate the lease. The Appeal Court held that since Highway Properties case, landlords have the option to take steps to mitigate damages without risk that they will be later estopped from claiming ongoing or prospective damages.

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