Withholding consent to assignments: a primer
The issue of when a landlord can refuse to consent to the assignment of a lease remains a notable source of litigation in the commercial real estate space. While lease agreements typically contain provisions permitting the tenant to assign upon securing the landlord’s consent (such consent not being unreasonably withheld), parties tend to arrive at significantly different interpretations of such clauses when faced with a dispute. The purpose of this article is to provide an overview of the law in this area in an effort to help landlords and tenants better position themselves when considering the assignment of commercial leases.
In 2002, the Court of Appeal for Ontario offered a salient summary of the law of assignments in Rodaro v. Royal Bank (2002), 59 O.R. (3d) 74. Writing for the Court, Doherty J.A. stated:
"Aside from limitations imposed by statute, public policy or the terms of a specific contract, a party to an agreement may assign its rights, but not its obligations under that agreement, to a third party without the consent of the other party to the contract. A party will not, however, be allowed to assign its rights under a contract if that assignment increases the burden on the other party to the agreement, or if the agreement is based on confidences, skills or special personal characteristics such as to implicitly limit the agreement to the original parties.”
This suggests that where a lease is silent as to the issue of assignment, the tenant may generally assign its interests without obtaining the landlord’s consent unless: (a) the assignment would increase the burden on the landlord; or (b) the landlord initially elected to enter into the lease owing to the tenant’s confidences, skills or special characteristics. The issue becomes more complicated in circumstances where the parties turned their minds to the issue and included the common-place restriction in which the tenant is required to secure the landlord’s consent before an assignment can occur. This restriction is typically softened by the qualifier that the landlord may not unreasonably withhold such consent. Moreover, subsection 23(1) of the Commercial Tenancies Act provides that unless a lease contains an express provision to the contrary, it will be deemed to include a clause prohibiting the landlord’s consent from being unreasonably withheld.
Shortly after the Court of Appeal’s decision in Rodaro v. Royal Bank, the Ontario Superior Court of Justice released what is widely regarded as the leading Ontario authority on the process to be followed in determining whether a landlord has unreasonably withheld consent. In 1455202 Ontario Inc. v. Welbow Holdings Ltd., 2003 CanLII 10572, Culluti J. offered the following guidance:
- the burden is on the tenant to satisfy the court that the landlord’s refusal was unreasonable;
- in determining the reasonableness of a refusal to consent, it is the reasons given by the landlord at the time the refusal was made, and not any additional or different reasons provided subsequently to the court, that are material
- as a general rule, the landlord may reasonably withhold consent if the assignment is expected to diminish the value of its rights under it;
- a probability that the proposed assignee will default in its obligations under the lease may be a reasonable ground for withholding consent;
- the financial position of the assignee may be a relevant consideration; and
- the question of reasonableness is essentially one of fact that must be determined on the circumstances of each particular case, including the commercial realities of the market place and the economic impact of an assignment on the landlord.
As suggested by the Ontario Superior Court of Justice in the recent 2010 decision in Suncor Energy Products Inc. v. 2054889 Ontario Ltd.,  O.J. No. 5129, commercial realities play perhaps the most important role in determining whether a landlord’s consent has been unreasonably withheld. In that case, the terms of a lease of a gas station provided that the tenant could assign upon obtaining the consent of the landlord, such consent not to be unreasonably withheld. The landlord refused to consent on the mistaken belief that the assignment would erode the financial value of the leased premises. The Court, upon hearing evidence submitted by both parties, found that the landlord would in fact be much better positioned from an economic perspective if it consented to the assignment. Accordingly, the court held that the landlord was being unreasonable and concluded that the refusal was invalid.
The assignment of leases is a quintessential example of a complex legal issue disguised as a straight forward affair. Landlords and tenants should exercise care in ensuring that their intentions with respect to assignments are clearly set out at the onset of the negotiating process in order to mitigate the need for future judicial intervention.
April 28, 2011 in Leasing | Permalink | Comments (11)
Exercising a termination clause requires strict satisfaction of any attached conditions
The Court of Appeal for Ontario recently articulated the importance of satisfying the conditions attached to termination clauses when seeking to terminate a lease. What the trial court considered to be a largely semantic point in Dunnville Soccer Park Corp. v. Haldimand (County),2010 ONCA 680 was ultimately found to render the landlord’s termination invalid.
The issue that gave rise to the dispute in this case concerned a long-term lease of 16 acres of playing fields. Under the terms of this lease, the Dunnville Soccer Park Corporation (“Dunnville”) and the Haldimand Youth Soccer Club, as tenants, took on the responsibility of developing soccer facilities on the premises while the Haldimand County, as landlord, was tasked with maintaining the turf. A termination clause afforded the landlord the right to terminate upon 180 days’ notice on the condition that it provided the tenants with “another reasonably similar soccer facility”.
A dispute arose between the tenants that resulted in the Haldimand Youth Soccer Club informing the landlord that it was no longer associated with Dunnville and requesting that it be removed as a party to the lease. Upon receiving this information, the landlord provided the two tenants with notice of termination and subsequently attempted to negotiate a new lease of the same premises with Dunnville on similar terms, with the notable difference that the parties would share the costs associated with turf maintenance. Reluctant to take on this new obligation, Dunnville commenced an application to determine the status of the original lease.
Advancing the position that the lease had been invalidly terminated on the basis that the landlord failed to provide it with “another reasonably similar soccer facility”, Dunnville argued that the lease remained in full force and effect. Specifically, Dunnville submitted that the landlord’s attempt to negotiate a new lease of the same premises on different terms did not satisfy the condition attached to the termination clause. The landlord, in response, maintained that its attempt to negotiate a new lease of the same premises amounted to an offer of “another reasonably similar soccer facility”.
The trial court determined that the landlord’s notice of termination was valid, holding that the landlord had satisfied its obligation to provide a replacement facility. The trial judge remarked that the proposed new lease would have provided Dunnville with the use of the same premises on “similar terms” to those in the original lease. The Court of Appeal reversed this decision, finding instead that the condition attached to the termination clause clearly required the landlord to provide the tenant with another reasonably similar soccer facility at another location, not the same facility on less favourable terms. Having failed to satisfy with this condition, the Court concluded that the landlord’s termination was invalid.
Given the Court of Appeal’s decision in this matter, landlords may wish to exercise a heightened sense of caution when considering whether to accept conditions attached to termination clauses.
April 28, 2011 in Leasing | Permalink | Comments (6)
Sovereign Immunity and the Challenge of Leasing to Foreign State Tenants
Leasing real property to foreign states presents a unique challenge to landlords. The operation of the doctrine of sovereign immunity, if not properly addressed in the lease instrument, can severely impact a landlord’s ability to seek recourse from the courts when faced with a problematic tenant. The aim of this article is to concisely set out the principal issues that should be considered by landlords whose portfolios include consulates, embassies or other foreign state tenants.
i. The application of sovereign immunity to lease agreements
As set out in the State Immunity Act (“SIA”), the Foreign Missions and International Organizations Act and the few cases within which these legislative instruments have been considered, the doctrine of sovereign immunity applies to leases in favour of consulates and other foreign state tenants. The 2008 Superior Court of Quebec decision in Teitelbaum v. 9093-8119 Quebec Inc. and the 1980 Ontario Supreme Court decision in Royal Bank of Canada v. Corriveau are particularly helpful in illustrating the application of sovereign immunity in this context. In both of these cases, the courts specifically remarked that the operation of a consulate or embassy is a sufficiently “governmental activity” to capitalize on the protection offered by the SIA.
ii. What if the foreign state tenant fails to plead immunity
Section 3 of the SIA establishes a presumption of sovereign immunity that operates notwithstanding a state’s failure to plead it. The onus of defeating this presumption falls on the party that is opposing the foreign state. This may be achieved by persuading the court that the opposing party should be able to rely on one of the exceptions to sovereign immunity set out in the SIA (e.g. that the foreign state is actually operating a purely commercial entity out of the premises). For greater clarity, sovereign immunity is presumed to apply notwithstanding a state's inaction unless the opposing party establishes that an exception is available or the state submits to the jurisdiction of the Canadian court.
iii. Landlord remedies in the face of sovereign immunity
Although the SIA establishes a presumption of immunity from the court's jurisdiction, it does not expressly contain prohibitions preventing private parties from exercising their contractual rights when doing so does not require the court’s intervention (e.g. re-entering and changing locks). Accordingly, landlords may have some latitude in exercising self-help remedies. While self-help does not appear to be restricted by the SIA, there is debate within the legal community as to how much protection the doctrine of sovereign immunity will afford to the foreign state tenant if the landlord elects to re-enter the premises. Some commentators have suggested that it may be possible for a tenant to rely on the provisions of the Foreign Missions and International Organizations Act as a way to restrain the landlord from exercising its right of re-entry, although this does not appear to have been litigated as a live-issue.
In addition to the potential for self-help, landlords may be able to turn to section 6 of the SIA. This provision provides an exception to the presumption of immunity in circumstances where a foreign state is a party to a proceeding that concerns “damage to or loss of property that occurs in Canada”. While the judicial definition of “property” in this context means tangible property and therefore does not extend to pure economic loss, this is an exception that landlords may be able to leverage in circumstances where it the tenant’s conduct has resulted in damage to or loss of the leased property.
iv. Voiding the application of sovereign immunity in the future
It is possible for landlords with substantial bargaining power to avoid the operation of sovereign immunity. Subsection 4(2)(a) of the SIA allows foreign states to explicitly submit to the jurisdiction of Canadian courts by written agreement. While this may be difficult for landlords to secure, the inclusion of such a clause in a lease agreement ensures that the foreign state will be subject to the same judicial reach as the typical Canadian tenant. Such a waiver may take the following form:
The Tenant hereto unconditionally and irrevocably:
agrees that the execution, delivery and performance by it of this Lease and all other agreements, contracts, documents and writings relating to this Lease shall be deemed to constitute private and commercial acts and not public or governmental acts for all purposes related to this Lease;
agrees that should any proceedings be brought against it or its assets in any jurisdiction, in relation to this Lease or any transaction contemplated by this Lease, no immunity, sovereign or otherwise, from such proceedings, executions, attachment or other legal process shall be claimed by or on behalf of itself or with respect to any of its assets;
consents generally in respect of the enforcement of any judgment against it in any proceedings in any jurisdiction to the giving of any relief or the issue of any process in connection with such proceedings including without limitation the making, enforcement or execution against or in respect of any property irrespective of its use or intended use subject to subclause 2 above.
By being aware of the doctrine of sovereign immunity from the onset of the negotiation process, landlords will be better positioned to successfully navigate the unique challenges of leasing to foreign state tenants.
February 24, 2011 in Leasing | Permalink | Comments (8)
Qualifying Criteria for Real Estate Investment Trusts Expected to Improve in 2011
Real estate investment trusts (“REITs”) are publicly-traded trusts that are considered attractive investment vehicles because they offer an exemption from the tax on distributions from specified investment flow-throughs. In December 2010, the federal government announced several proposed changes to the income tax rules applicable to REITs, a number of which will be of significance to the commercial real estate community.
The proposed amendments are chiefly concerned with the criteria that investment trusts must meet in order to qualify as REITs. Expected to come into force in 2011, these amendments will also be applicable on an elective basis for post-2006 taxation years if certain conditions are met. A brief overview of the most notable elements of the proposed amendments is provided below:
i. Qualified REIT Property
Under the current rules, REITs are generally prohibited from holding any “non-portfolio property”, being investments other than “qualified REIT properties”, at any time in the taxation year. Perhaps most significant of the amendments is an allowance permitting these trusts to hold up to 10% of their non-portfolio property in assets that are not qualified REIT properties without losing their status.
“Non-portfolio property” typically includes:
- property used in carrying on a business; and
- securities of an entity that represent more than 10% of the equity value of the entity or more than 50% of the equity value of the security holder.
Under the current rules, “qualified REIT property” includes:
- real or immovable property;
- property ancillary to earning of rents and capital gains from dispositions of real or immovable property; and
- some types of qualifying subsidiaries.
This welcoming allowance provides a much needed degree of flexibility and safe harbour for REITs that face unexpected or unintended property issues.
ii. Source and Nature of REIT Revenue
In order to qualify as an REIT, an investment trust must meet two tests designed to determine the nature of its revenue. The current qualification rules require that at least 95% of an REIT’s revenue be derived from passive sources and that at least 75% come from certain passive real estate sources. The proposed amendments reduce the 95% passive revenue source requirement to 90% and clarify that, for both tests, revenue is to be defined as gross revenue inclusive of capital gains.
The proposals go on to clarify that, for purposes of the two thresholds tests referred to above, amounts paid by certain subsidiaries of an REIT to the REIT will have the same character as it had when it was received or earned by the subsidiary. It is expected that this change will serve a beneficial clarification for tax planning purposes.
iii. Foreign Currency Gains
When REITs hold foreign real or immovable property, they may finance the acquisition of such property using debt denominated in a foreign currency. Given the potential foreign currency risk in holding foreign assets, REITs may choose to enter arrangements in an effort to hedge that risk. To that effect, the proposed amendments will allow REITs to earn, as qualifying revenue, gains realized from foreign currency fluctuations in respect of revenues derived from foreign real or immovable property, exposing investors to additional revenue sources.
While the final form of these proposed amendments remains to be seen, collectively they appear to improve the attractiveness of real estate investment trusts for those looking beyond securities. By providing both clarification and improved qualification thresholds, the amendments modify the rules governing REITs in a manner that better reflects the practical realities within which these investment vehicles operate.
January 26, 2011 in Leasing | Permalink | Comments (10)
Entitlement to Post-Closing Property Tax Refunds: 80 Mornelle Properties Inc. v. Malla Properties Ltd.
80 Mornelle Properties Inc. (the “Vendor”) was the owner of an apartment building in Toronto prior to selling it to Malla Properties Inc. (the “Purchaser”) in October 2006. Before the sale, the Vendor retained lawyers to appeal the property’s tax assessment and continued to pursue the assessment appeal well after the transaction closed. The Vendor was eventually successful in this reassessment, with the result that a tax refund of $251,166.43 was owed for the period of 2003 to 2006.
The City of Toronto paid this refund to the Purchaser in compliance with section 306(2) of the City of Toronto Act, 2006. This section provides that property tax refunds are to be paid “to the owner of the land as shown on the tax roll on the date that the adjustment is made”. Upon learning of the refund, the Vendor asked the Purchaser for the refund less the portion of it that related to the period after the sale. When this request was refused, the Vendor commenced an application to force the Purchaser to disgorge a majority of the refund.
At trial, the application judge determined that, at the time the property was sold, the most that the Vendor could be said to have in respect of its assessment appeal was a “contingent prospect for receiving a tax refund in an amount yet to be determined”. As the Vendor could not have sued on the basis of such an interest, the Court concluded that this interest did not constitute a chose in action. The application judge then considered whether the doctrine of unjust enrichment could be leveraged so as to require the Purchaser to disgorge the refund. Although the case law favoured the Vendor on this point, the Court concluded that the operation of section 306(2) of the City of Toronto Act, 2006 (requiring payment to the owner of the land as of the date that the adjustment was made)constituted a juristic reason for the Purchaser’s enrichment.
The Court of Appeal reversed this ruling. It held that the Vendor’s application should succeed on the grounds that it both overpaid taxes on the property during the period in which it was the owner and took the necessary steps to have the taxes reassessed. Ultimately, the right to receive the proceeds of the assessment appeal was a chose in action – an intangible personal right enforceable by legal action. This chose in action did not automatically run with the property when it was sold and, as the Vendor did not explicitly assign this right to the Purchaser, it retained its entitlement to the refund notwithstanding the sale.
The Court of Appeal then considered whether the City of Toronto Act, 2006 should operate as a bar to the Vendor’s application. Writing for the Court, Gillese J.A. observed that nothing in the legislation indicated that the legislature intended to interfere with the rights of property owners. Since express wording is necessary if the courts are to interpret legislation as having adversely affected a person’s rights, it could not be said that the legislature intended section 306(2) to strip the Vendor of its right to sue for the refund. Given the findings that the Vendor retained a chose in action and that the City of Toronto Act, 2006 was not a juristic reason for the enrichment, the Purchaser was ordered to disgorge the refund less the portion of it that related to the period after the sale.
The Court of Appeal’s decision is consistent with the practice on a real estate transaction. In a typical transaction the parties would have specifically dealt with this matter by an undertaking of the Purchaser to pay over to the vendor the appropriate share of any refund if and when received.
January 5, 2011 in Leasing | Permalink | Comments (7)
"Unreasonable" refusal to grant consent to a lease assignment
Commercial leases commonly provide that the tenant may not assign or sublet the lease without the landlord’s consent, such consent “not to be unreasonably withheld”. In Ontario, a landlord may not withhold its consent solely to secure a new advantage uncontemplated by the terms of the lease.
This issue recently came before the Ontario Superior Court of Justice in the case of Tradedge Inc. v. Tri-Novo Group Inc., 84 R.P.R. (4th) 84. There, the tenant’s business came under severe financial constraints and it entered into a sale agreement which was conditional on an assignment of the tenant’s lease.
The terms of the lease prohibited the tenant from assigning the lease without the landlord’s consent (such consent not to be unreasonably withheld).
The purchaser (“proposed assignee”) entered into preliminary negotiations with the landlord over the terms of the lease assignment during which it provided the landlord with information about its proposed new business. After reviewing that information, the landlord refused a straight assignment without conditions, alleging that the proposed assignee was not in a satisfactory financial condition.
The landlord was willing to grant its consent if the proposed assignee agreed to pay an increased rent and addressed the landlord’s concerns about its protection in the event of the proposed assignee’s default by agreeing to additional lease terms. However, when the landlord provided these additional lease terms, many of them were unrelated to the proposed assignee’s financial condition. The proposed assignee refused to agree to the additional lease terms but offered to post a $100,000 letter of credit as well as confirmation that its bank had approved a $250,000 loan, including $150,000 for renovations to the premises.
Following further discussions, the proposed assignee agreed to pay the increased rent, as well as a deposit towards the landlord’s legal costs for the assignment. The tenant, however, refused to agree to the assignment unless the landlord agreed to pay the tenant’s legal fees and provide a certain period of rent relief. As a result, consent to the assignment was not given by the landlord and the lease was not assigned.
The tenant left the premises and the landlord leased them to the proposed assignee at a higher rent and with a $175,000 inducement for the landlord to sign the lease. The tenant proceeded to bring an application that the landlord had unreasonably withheld its consent in order to benefit itself by re-leasing the premises.
The court agreed with the tenant and found that the landlord would not have been worse off by consenting to the assignment, but rather may have been better off given the financial condition of the tenant. The landlord had acted unreasonably in refusing to grant its consent to the assignment.
This case illustrates that a landlord’s refusal to grant its consent to a tenant’s request to assign the lease will be seen by the court to be unreasonable where it is designed to obtain a benefit to the landlord which is unconnected to the existing terms of the lease.
April 10, 2010 in Leasing | Permalink | Comments (4)
Subrogated Claims by Insurers in Commercial Leases (Part VI) - Update on 1044589 Ontario Ltd. v. AB Autorama Ltd.
In several previous posts we have addressed recent cases relating to subrogated claims by insurers in commercial leases. A subrogated claim refers to the claim by which an insurance company seeks recovery of the amount it pays to a policy holder from a third party who may have caused the loss.
In October of 2008, we commented on the Ontario Superior Court of Justice’s decision in 1044589 Ontario Inc. c.o.b. Nantuckett Business Centre v. AB Autorama Ltd. (2008 CanLII 394435 ONSC) (“Autorama”). This post follows a reversal of that decision by the Ontario Court of Appeal.
In Autorama, the landlord and tenant signed an Offer to Lease for an auto body shop in a strip mall. The Offer provided that the tenant would pay its proportionate share of the operating costs of the building, which included the cost of insuring the building. While the tenant was required to contribute to the cost of insurance, the Offer did not contain a corresponding covenant of the landlord to obtain insurance.
A fire started in the tenant’s unit and caused damage to the building and its contents, as well as an interruption of business and a loss of profits for the landlord. The parties brought a motion to the Ontario Superior Court of Justice to decide whether the terms of the Offer permitted the landlord to sue the tenant for damages (and its insurer to make a subrogated claim standing in the shoes of the landlord) or whether, when it included insurance as part of the cost of the tenant’s proportionate share of the cost of the premises, the landlord assumed the risk of damage by fire, and thus could not sue the tenant for damages arising from the tenant’s negligence. The motions judge had held that under the terms of the Offer, the Tenant assumed the risk for any losses caused by the tenant’s negligence and that the Landlord was not precluded from pursuing a claim against the tenant.
The tenant appealed the decision.
The Ontario Court of Appeal allowed the appeal, set aside the order of the motions judge and ordered that the landlord is precluded from maintaining its claim against the tenant.
In reaching its conclusion, the Court of Appeal held that Ross Southward Tire Ltd. v. Pyrotech Products Ltd.,  2 S.C.R. 35 (“Ross”), a Supreme Court of Canada case was in substance identical to the present case and dispositive of the appeal. Ross had been considered by the motions judge, but was incorrectly distinguished on the basis that the landlord had covenanted to insure the property against fire loss (when in fact it had not).
The lease in Ross stated that “the lessee shall pay all realty taxes including local improvements and school taxes, electric power and water rates and insurance rates immediately when due.” The Supreme Court held that the obligation to pay all insurance rates included fire insurance and that because the lessee paid for insurance, it received the benefit of insurance coverage.
The same reasoning was applied by the Court of Appeal in the present case. The provision in the Offer requiring the tenant to contribute to all costs of insurance had the effect of allocating the risk of fire loss to the landlord.
The decision of the Court of Appeal is more in line with the majority of the case law and the generally accepted thinking on the subject. The landlord had insurance which the tenant paid for, so why should the tenant not benefit from that?
This case also illustrates the hazards of parties choosing to live under the terms of an offer to lease, rather than proceeding with a lease. It is likely that the parties here would have turned their minds more fully to insurance obligations and allocation of risk during negotiation of the lease terms and perhaps avoided the litigation.
February 1, 2010 in Leasing | Permalink | Comments (7)
Landlord's Termination Right in Lieu of Granting Consent to Sublease, Etc.
Almost all commercial leases will restrict a tenant from assigning, subleasing or otherwise dealing with its lease without the consent of the landlord, with the landlord generally agreeing to not unreasonably withhold such consent. It is also very common in a commercial lease to provide the landlord with a right, in lieu of granting such consent, to terminate the lease and take back the space. This is an additional right bargained for by the landlord so it can regain control of the space (rather than let it go to another occupant) if it so desires.
From time to time it seems that the landlord’s exercise of this right following a request for consent comes as a surprise to a tenant. The tenant may be trying to protect a sale of a business, a lower lease rate or some other interest. In those circumstances a tenant may take the position that the landlord’s termination right is not an independent right but must be read in conjunction with its obligation to act reasonably in considering consents.
Two Ontario cases have dealt with this issue.
In 590207 Ontario Limited and 526442 Ontario Limited v. Mascan Corporation and Hammerson Canada Inc. (Ontario District Court, August 15, 1985) the Court held that the landlord was merely exercising its right to elect to terminate the lease in lieu of either giving or withholding consent and in those circumstances it cannot be said that the landlord’s consent was unreasonably withheld. The landlord was simply exercising an option available to it pursuant to the lease and the tenant’s application to determine whether the landlord has unreasonably withheld consent was dismissed.
However, there is a conflicting result in Priftisv.Trilea Holdings Inc. (Ontario District Court, June 17, 1988). In this case, the Court held that the provision in the lease permitting the landlord to terminate on the mere request of the tenant to assign the lease was contrary to the earlier lease provision that consent to an assignment was not to be unreasonably withheld. The Court resolved the ambiguity in favour of the tenant.
This issue was most recently considered in the Alberta decision of Orbus Pharma Inc. v. Kung Man Lee Properties Inc., 2000 ABQB 754 (CanLII). In this case the tenant made a written request to the landlord for its consent to assign the lease. The landlord elected to exercise its option to cancel the lease in preference to giving that consent. The tenant brought an action against the landlord claiming the landlord was in breach of its obligation under the assignment and sublease provisions of the lease for unreasonably withholding its consent.
The landlord argued that the question of being reasonable was not relevant when it exercised its termination right as the landlord’s options were to:
(a) in the event there was a reasonable basis to withhold consent;
(i) withhold consent;
(ii) consent; or
(iii) terminate the lease; and
(b) in the event there was no reasonable basis to withhold consent:
(i) consent to the assignment; or
(ii) terminate the lease.
That is, the landlord argued it could terminate the lease in either case, whether there was a reasonable basis to withhold consent or not.
The tenant took a different interpretation of the lease. In the tenant’s view:
(a) in the event there was a reasonable basis to withhold consent then the landlord could:
(i) withhold consent;
(ii) consent; or
(iii) terminate the lease; and
(b) in the event there was no reasonable basis to withhold consent, then the landlord was limited to consenting to the assignment and the termination right did not operate.
The court agreed with the landlord finding that the landlord had the separate contractual right to terminate the lease in preference to the consenting to the requested assignment. In its decision the court considered the Priftisv.Trilea Holdings case referred to above and found that the lease there was worded differently and therefore that case was not helpful to the tenant.
As with many lease issues, the decision ultimately turned on the drafting of the lease. Once again, this shows the importance of how lease provisions are drafted.
May 25, 2009 in Leasing | Permalink | Comments (3)
The Purchaser's Right to Rescind: Easements Materially Affecting Use
Typical language in an agreement of purchase and sale provides that the purchaser agrees to accept title “subject to any easements for sewers, drainage, public utilities, phone or cable lines or other services that do not materially affect the present use of the property.” Language such as this is usually found in either a preprinted form that may be used by the parties or in specifically negotiated “Permitted Encumbrances” in larger deals.
In Ontario, the test for whether an easement materially affects the use of a property is set out by Justice Moldaver in Stefanovska v. Kok (1990), 73 O.R. (2d) 368 (Ont. H.C.):
… the test to be applied is whether the vendor can convey substantially what the purchaser contracted to get. In this regard, all of the surrounding circumstances must be considered to determine if the alleged impediment to title would, in any significant way, affect the purchaser’s use or enjoyment of the property.
Justice Forestell, in Ridgely v. Nielson,  O.J. No. 1699 (Ont. S.C.J.), outlined four factors to be considered in determining whether an easement is material: the location of it; the size of the easement; the point of access; and the owner’s enjoyment of the property.
The point at which an easement “materially affects” a purchaser’s use of a property was recently considered by the Ontario Superior Court of Justice in Macdonald v. Robson (2008), 76 R.P.R. (4th) 156.In this case, the parties entered into an agreement of purchase and sale for a two acre property. The purchaser gave evidence at trial that the property suited his interests as its lay-out would enable him to build a structure on the west side of the property to house his tractor.
In many transactions involving the purchase and sale of a business, the seller may not own the property where the business is carried on but may have an existing lease of the property. In a situation where there is a lease, the buyer often requires the continuation of the lease in order to carry on the business after the completion of the transaction. This can involve an industrial, retail or office lease. Take, for example, the purchase of a warehouse and distribution business, the purchase of a chain of restaurants or retail stores, or even the purchase of a professional or other service firm. In each of these cases, the lease will likely be a key element to the ongoing operation and ultimately the success (or failure) of the business. It is important, therefore, to carry out a review of the lease. The extent and detail of the review will depend on the nature of the transaction. An experienced commercial leasing lawyer and commercial leasing agent are the best people to help and guide you through the lease review process. Set out below are a number of factors that should be considered in reviewing the lease. This is not an exhaustive list, and all factors may not apply to your lease review.
Lease and Parties
Begin your lease review by obtaining a complete copy of the lease, all lease extension and amending agreements, all prior assignments, subleases, estoppel certificates, leasehold mortgages, if any, and similar related documents. Note all the parties, beginning with the landlord and the tenant. The current landlord and tenant may be different from what is shown on the current lease documents. You will need to obtain the necessary documents in order to establish that you are dealing with the current landlord and the current tenant. There may also be an indemnifier or guarantor. There may even be a leasehold mortgage which will have to be dealt with as part of the transaction.
When you are determining the parties to the lease, it is important for your lawyer to carry out due diligence with respect to title and zoning. Even though the seller is not the owner of the property where the business is carried on, the seller, in our situation, has a leasehold interest. A leasehold interest is more than a contractual right; it is also an interest in land. In most cases, it is not necessary to carry out a full title search. As a matter of fact, it is rarely done. Most titles in Ontario are registered under the land titles system. (Based on most recently available information, approximately 96% of all properties in Ontario are governed by the provisions of the Land Titles Act). The title search will provide you with the name(s) of the current owner, any existing mortgagees (including leasehold mortgagees), and any registered restrictions affecting the property. It will also disclose whether notice of the lease has been registered. Notices of lease are particularly important where there is an extended term with extension and other special rights. This will be discussed more fully below. The current owner should be the landlord, but this is not always the case. The landlord may be a former owner or may even be a tenant under a head lease. This means that the lease being taken over is not a lease but a sublease. Any default by the sublandlord as tenant under the head lease puts the subtenant at risk unless there is a non-disturbance or similar agreement with the head landlord. Similarly, any default by the landlord under any existing mortgage or debenture can also put the tenant at risk, unless there is a non-disturbance agreement in place between the tenant and the mortgagee or debenture holder. All of this information is important in order to assess the extent to which the tenant’s leasehold interest may be at risk. Any termination or other forfeiture of the tenant’s leasehold interest will place the continuation of the business at risk.
Regarding use, there are three things to check. Check the permitted uses under the lease. Check the applicable zoning bylaws regarding permitted uses. Check the title search to determine if there are any exclusive or prohibited uses set out in any prior notices of lease or other instruments on title.
Most commercial leases, whether industrial, retail or office, are net leases; that is, there is a base (or minimum) rent component, as well as an additional rent component consisting of operating costs, realty taxes and utilities. Retail leases often include an additional percentage rent component. With respect to additional rent and percentage rent (if any), these amounts are based on current estimates and will be subject to adjustments after the completion of the current fiscal year. For that reason, it is important to include reciprocal undertakings to readjust these items of rent after closing. While the amount of base rent is a fixed amount, all other components of additional rent are variable, which from a realistic point of view means that these amounts will increase. Note the major items included in and excluded from operating costs, particularly the tenant’s obligation to pay its share of extensive capital repairs. Are utilities (in particular, electricity) separately metered or bulk metered? What is the amount of the management fee and to what items of additional rent is the management fee applied? These are some of the basic type questions that should be answered.
Determine if any deposits have been paid. If yes, there would be a credit to the seller provided the buyer obtains confirmation from the landlord that it is holding the deposit to the credit of the tenant. (This statement is usually included in the estoppel certificate discussed below.) The deposit may be in the form of a letter of credit which will have to be replaced by a letter of credit provided by the buyer’s bank and the old letter of credit surrendered to the seller.
It goes without saying that the location of the premises is of paramount importance. Look for a plan, sketch or other description that clearly outlines the extent of the premises. Base rent, additional rent and percentage rent (if any) are usually based on a price per square foot. The calculation of the area of the property being leased is therefore important. Try to obtain an area certificate that confirms the calculation of the area in accordance with the terms of the lease or, alternatively, confirmation of the area in the landlord’s estoppel certificate. There may be related facilities such as storage, parking and outdoor areas that should also be checked. In many cases, storage and parking are covered by separate licenses. Ensure that these licenses have been included in the lease documentation that you received at the beginning of the transaction and that the leases or licences of storage, parking and outside areas can be assigned.
The remaining term of the lease and any unexercised extension rights should be carefully noted. Pay close attention to the conditions of exercising any extension rights. Many leases have provisions that make extension rights non-assignable.
The assignment and sublet provisions require careful scrutiny not only to determine whether the landlord’s consent is required but also what conditions can be imposed by the landlord in giving its consent. The place to start when reviewing these provisions is the definition of “assignment” and “sublease”. Quite frequently the defined term “transfer” is used to include not only an assignment and sublease but also a change of corporate control. In the more “landlord friendly” leases, it is common to find a landlord’s termination right in the event a tenant requests consent to transfer the lease. This would be an obvious “deal breaker” if the lease is essential to the continued operation of the business. The same “landlord friendly” leases often give the landlord the opportunity to amend the terms of the lease and to require additional financial security. It is evident that the landlord’s cooperation in providing its consent on reasonable terms is a critical part of the transaction. Assessing the position of the landlord is one of the critical first elements of the entire transaction where consent to the transfer is required. Even if no consent is required, there will likely be a provision requiring notice to the landlord along with an assumption agreement to be entered into between the landlord and the buyer. Such terms are not particularly onerous. What can become an issue in many transfers is the loss of special rights under the lease. The possible loss of extension rights has already been discussed. Other special rights such as tenant signage, expansion rights, exclusive uses, audit rights, and parking are a few of the more common examples of special rights that may be lost in the event of a transfer. Look for defined terms such as “required conditions” or “threshold conditions” in the lease that set out a variety of requirements that must be met before these special rights can be exercised.
What is also important from a buyer’s perspective is to obtain an estoppel certificate from the landlord. It may be surprising to some that a tenant may not have the right to require the landlord to provide an estoppel certificate. In many “landlord friendly” leases, only a landlord has the right to require the tenant to produce such a certificate and, as indicated, such right to a certificate is not necessarily reciprocal. The main point to remember is that the landlord’s cooperation is essential in these transactions for a variety of reasons.
The distinction between tenant leasehold improvements and trade fixtures is by no means clear-cut. The point to remember is that in most, if not all, leases there are both leasehold improvements and trade fixtures. Many leases will contain a somewhat circular definition of leasehold improvements similar to the following:
“Leasehold Improvements” means all fixtures, improvements, installations, alterations and additions from time to time made, erected or installed by or on behalf of the Tenant or any former occupant of the Premises, including doors, hardware, partitions (including moveable partitions) and wall-to-wall carpeting, but excluding trade fixtures and furniture and equipment not in the nature of fixtures;
Many commercial leases provide that the landlord is the owner of all leasehold improvements regardless of who paid for them. This may be an important element when determining the allocation of any purchase price with respect to leasehold improvements. (Note that many commercial leases contain restrictions on tenants obtaining any compensation for leasehold improvements.) Also, leasehold improvements constitute alterations that, in most cases, require the landlord’s consent. If an existing tenant has carried out alterations to the premises without the required consent, the assignee tenant will be at risk unless the estoppel certificate confirms that all leasehold improvements have been approved. Having confirmation that all leasehold improvements have been approved does not, however, protect the assignee tenant from any restoration obligation. The restoration obligation is discussed below. With respect to trade fixtures and other personal property, these may be subject to a general security agreement provision found in some commercial leases. Such provisions will likely conflict with other security agreements between the buyer and its lender.
Other Clauses to Look For
(i) Sale Demolition
The effect of this clause is to allow the landlord to terminate the lease in the event of any sale of the property or any demolition of the building. Obviously such a clause can have a serious impact on the tenant’s ability to continue to operate the business.
(ii) Repair Obligations
Repair obligations vary considerably from one lease to the other. In order to make sense of these obligations, check the definition of the premises which sets out the boundaries or limits. The repair obligations with respect to the premises would only apply within those boundaries or limits. For example, if the upper limit extends to the underside surface of the ceiling tile, the space between the ceiling tile and the ceiling slab would not form part of the premises. Ideally, the tenant would only want to be responsible for interior non-structural repairs and ordinary cleanliness.
The requirement for the tenant to restore and return the premises to a base building condition on termination can be a very costly obligation for a tenant, especially when there have been significant leasehold improvements and other alterations.
(iv) Post-Dated Cheques
Surprisingly, most commercial leases still contain a requirement for post-dated cheques although as a matter of practice, few landlords enforce this provision. The more current requirement is to provide for payment by way of automatic debit and this may be problematic for some tenants.
(v) Risers and Conduits
The right to access and use the risers and conduits in a building is not necessarily assured. While such access may not be much of an issue in industrial and retail premises, it can definitely be an issue in office buildings, in particular, older office buildings. There may be no room for additional wires or cabling and this would be a serious impediment to the tenant’s ability to communicate electronically. It should not however be an issue for an existing lease situation where all the cables and wires are presumably already in place. It may become an issue in the event the tenant assignee needs to upgrade its communication systems.
(vi) Environmental Audits
Many industrial leases include the right of the landlord to require an environmental audit. Not only is there a significant cost involved, there is also the potential risk that the tenant assignee may be held responsible for environmental contamination caused by previous tenants. Depending on the nature of the business transaction, it may be appropriate for an environmental audit to be carried out before the completion of the transaction as protection for the tenant assignee.
(vii) Repayment of Improvement Allowance
In many commercial leases, new tenants may have benefited from a leasehold improvement allowance. Normally, the cost of the leasehold improvement allowance is included in the base rent amortized over the initial term of the lease. Some leases however do not blend the leasehold improvement allowance into the base rent and treat such allowance as a debt repayable in addition to the base rent. While the end result may be the same, it may be appropriate, depending on the nature of the business transaction, to adjust for such debt in a different manner than the base rent.
The landlord’s right to relocate is found frequently in commercial leases of tenants occupying smaller premises. If there is a relocation clause and the premises in their current location are of considerable importance to the ongoing business operation, the tenant assignee will be at risk. Location can be particularly important to a retail tenant. Despite the risk involved, it is rare to find a commercial lease where a landlord does not pay the cost of the relocation.
(ix) Insurance Requirements
The first step in dealing with the tenant’s insurance requirements is to bring it to the attention of the tenant’s insurance advisors to ensure that the proper insurance will be in place and a certificate of insurance provided in order to provide evidence to the landlord that this requirement has been met. In this context, the insurance coverage placed by the tenant assignee (or by any tenant, for that matter) should not only look to the minimum requirements of the lease but also to the extent and nature of the risks that are allocated to the tenant under the lease. For example, if the lease requires the tenant to obtain commercial general liability insurance in an amount not less than $2 million on the one hand and, on the other hand, allocates all of the risk to the tenant for any losses that may be incurred in the premises, however caused, together with a complete indemnity of the landlord, it is quite likely that an insurance advisor would recommend a greater amount of insurance. The main point to remember is that the insurance provisions cannot be viewed in isolation, but must be considered in light of all of the related provisions such as landlord releases and indemnities.
Expansion rights can be covered in a number of different ways. Keeping in mind that this right and other special rights may be limited in their application to tenant assignees, there are basically three different types of expansion rights:
This right allows the tenant during a certain period of time on giving of prescribed notice to expand its premises into a particular location usually adjoining the existing premises.
(b) Right of First Refusal
This right allows the tenant to match any offer received by the landlord with respect to a designated area (usually adjoining). The landlord is required to give notice of such offer to the tenant and the tenant has a prescribed period time in which to respond.
(c) Right of First Offer
This right requires the landlord to offer any available space to the tenant at fair market value before offering such space to third parties.
While the option is likely the most valuable of the various expansion rights, the others should not be discounted. All are valuable tools to allow for future growth.
(ii) Contraction/Partial Surrender
This right is the reverse of the expansion right. It allows the tenant, on giving notice of a prescribed (usually lengthy) period, to give back part of its premises to the landlord usually on payment of a termination fee. It is not often found in commercial leases and is usually tenant specific, that is, it cannot be assigned to subsequent tenants.
(iii) Early Termination
This is a variation of the contraction right in that it allows the tenant to advance the expiry date of the lease on payment of a prescribed termination fee and on giving a prescribed period of notice. As with the contraction right, the early termination right is usually tenant specific.
The audit right is a valuable tool for any tenant to control the amount of additional rent payable under the lease. The amount of operating costs, property taxes and even utilities are all determined by the landlord and those employed or retained by the landlord. The information provided by the landlord to the tenant at the end of each fiscal year can be sketchy and light on details. The tenant right to audit gives the tenant the opportunity to satisfy itself. The cost of the audit is normally borne by the tenant but many leases provide that if there is an error or other discrepancy greater than a certain percentage, the landlord will pay.
(v) Self Help
It is safe to say that all commercial leases allow the landlord to perform the tenant’s obligations if the tenant fails to do so. For example, if the tenant fails to repair or maintain its premises in accordance with the requirements under the lease, the landlord, after notice, can do so and all amounts spent by the landlord in carrying out the tenant’s work (and usually an additional 15% administration fee) are added to the rent and can be collected as rent. It is very seldom that a tenant has a reciprocal right to perform a landlord’s obligations if the landlord fails to do so. In many situations, it is not practical to have such a self-help right in a multi-tenant facility. The self-help right is usually found in large single tenant facilities or large retail stores where a tenant would have considerably greater negotiating clout than most other tenants.
A tenant right to install its trade name, logo or other identifying sign on the exterior of a building or other prominent place is of considerable value, especially to retail tenants. As with other special rights, such signage rights are often not transferable to assignees or subtenants.
The right of a tenant to an exclusive use within a building or shopping center is equally important, especially to retail tenants. Commercial landlords tend to be very careful about how such rights are negotiated. As can be expected, there are numerous conditions similar to “required conditions” referred to earlier.
(viii) Purchase Option
It is very unlikely that a lease will contain a purchase option, in particular, in multi-tenant facilities.
(ix) “Go Dark”
One of the standard default provisions in a commercial lease arises when the premises become vacant and unoccupied, usually for a period in excess of 10 days. A “go dark” right allows the tenant to vacate the premises and, so long as all the rent is paid and all other obligations are performed, it does not constitute a default under the lease. This right may become a valuable asset to some tenants as part of a business restructuring or similar undertaking.
(x) Roof Top/Generator
The right of access to the rooftop and other restricted areas not included in the definition of premises is a valuable right for those tenants who need to install telecommunications equipment and backup generators in order to ensure continued business operations.
Unfortunately there is no “fast track” process for carrying out a lease review. It is not advisable to rely on third party lease summaries. The better course of action would be to retain a commercial leasing lawyer or agent to review the lease and determine the tenant’s rights and obligations with respect to each of the factors listed above, as well as any others that are unique to your transaction. This will provide a reliable assessment of a key element of the business being purchased.