Third-Party Assurances
The Aftershock of Crystalline
As you will recall, in January of 2004, the Supreme Court of Canada released its long-awaited decision in Crystalline Investments Limited v. Domgroup Ltd. ("Crystalline"), [2004] S.C.J. No. 3. The Supreme Court in Crystalline, (upholding the decision of the Ontario Court of Appeal), held that the original tenant under a lease remains liable on the lease covenant notwithstanding that the lease has been assigned to an assignee who subsequently becomes insolvent and the lease has been disclaimed or repudiated in bankruptcy proceedings.
It appears that Crystalline has finally resolved the endless confusion surrounding the Ontario Court of Appeal’s affirmation of in Cummer-Yonge v. Fagot ("Cummer-Yonge") (1965), 2 O.R. 152 (Ont. H.C.), which held that a guarantor’s liability for a tenant’s lease obligations was extinguished upon the disclaimer of such a lease in bankruptcy. In obiter, the Supreme Court in Crystalline essentially overturned Cummer-Yonge. Noting that the House of Lords had overruled an English Court of Appeal decision which had the same result as Cummer-Yonge, the Supreme Court stated, "In my opinion Cummer-Yonge should meet the same fate. Post disclaimer, assignors and guarantors ought to be treated the same with respect to liability. The disclaimer alone should not relieve either from their contractual obligations."
The question that leasing lawyers are now asking themselves, post-Crystalline, is what level of certainty can be expected for landlords seeking to rely on other types of third-party assurances surviving their tenant’s bankruptcy?
The aftershock of Crystalline was felt almost immediately. In Bank of Montreal v. Clarica Life Insurance Co., [2004] O.J. No. 633 (Ont. C.A. ), the appeal dealt with whether a letter of credit would survive the disclaimer of a lease. The trial judge had held that the only basis upon which the bank could succeed in limiting the landlord’s claim for rent owing to the date of disclaimer was to establish fraud by the landlord. In February of 2004, the Bank of Montreal abandoned its appeal because it was of the opinion that the Crystalline decision had a significantly negative impact on its ability to succeed.
In the context of indemnification, this issue was more recently canvassed in KBBL No. 297 Ventures Ltd. v. IKON Office Solutions, Inc. ("KBBL"), [2004] B.C.J. No. 1894 (B.C.C.A.). The trial decision of this case was rendered just prior to Crystalline. In KBBL the indemnity agreement provided that "this agreement will only apply to obligations incurred or accruing due during the term of the lease." The trial court in KBBL held that the disclaimer of the lease terminated the lease and discharged the indemnitor of its obligations to the landlord for the bankrupt tenant under the lease. In reaching the decision, the trial judge relied heavily on Crown Pacific Development Ltd. v. Ferster (1991), 7 C.B.R. (3d) 91 (B.C.S.C.), a case that stemmed from the Cummer-Yonge line of authorities involving an indemnity agreement with similar language.
After Crystalline, the landlord in the KBBL case appealed the trial decision and sought to enforce the obligations under the indemnity agreement. The indemnitor argued that the specific terms of the indemnity agreement distinguished this case from Crystalline. However, the British Columbia Court of Appeal overturned the decision and held that the authorities relied on by the trial judge were no longer sound law in light of the Crystalline decision.
Nearly one year after Crystalline, landlords can be fairly certain that most third-party assurances will survive the tenant’s bankruptcy. One may query whether the leasing industry will continue to worry about careful drafting to circumvent the consequences of Cummer-Yonge.
Guarantors and Indemnifier Not Bound by Material Changes
It is well established in law that a breach by the debtor of the underlying contract in a manner that results in a material variation in risk to the guarantor will discharge the guarantor (Bank of Montreal v. Wilder, [1986] 2 S.C.R. 551). In Jens Hans Investments Co. Ltd. v. Bridger, [2004] B.C.J. No. 1206 ("Jens Hans"), the British Columbia Court of Appeal was recently faced with the problem of whether to extend the law of guarantee to the indemnifier of a commercial lease.
The trial judge in Jens Hans held that a failure by the landlord to reply to repeated requests for consent to a sublease was unreasonable and amounted to a fundamental breach of lease, which entitled the tenant to treat the lease as terminated. Further, the lower court held that the fundamental breach by the landlord served to absolutely discharge the indemnifier from all liability as the landlord had materially varied the risk assured by the indemnity agreement.
Relying on Richview Investments Inc. v. Dynasty Social Club (1997), 29 B.C.L.R. (3d) 348 (B.C.C.A.), the Court of Appeal in Jens Hans was of the view that the law of guarantee should be extended as "it would be odd if the law protected guarantors but failed to protect [the] indemnifier in almost identical circumstances." As a result of its unreasonable withholding of consent to sublet, the landlord dramatically increased the risk to the indemnitor and also prejudiced the rights the indemnifier had to subrogation and indemnification from the tenant.
If a material change to a lease increases the risk to the guarantor, can the guarantor be released from its obligation in spite of a clause in the guarantee providing that the guarantor will be bound by any amendment to the lease? This is precisely the issue addressed in Guinness Tower Holdings Ltd. v. Extranc Technologies Inc., [2004] B.C.J. No. 546 (B.C.S.C.).
In that case, the landlord and tenant entered into a five-year lease with a right of renewal and an option to expand the leased premises. The tenant used the premises to train ESL students, but as a result of complaints from other tenants, the terms of the lease were amended without notice to the guarantor. The amendments provided that the tenant would no longer be able to train ESL students and the landlord would have the right to terminate the expansion portion of the leased premise on 30 days’ notice. The wording of the guarantee purported to bind the guarantor no matter what changes were made to the lease. The court held that material changes had been made and despite the clause in the guarantee, equity will relieve the guarantor of his obligation unless he consents to such changes.
Relief from Forfeiture
Failure to Obtain Consent Leads to Forfeiture, but Equitable Relief Available
In Ontario, under s. 20(7) of the Commercial Tenancies Act, a tenant is unable to apply to a court for relief from forfeiture in circumstances involving a covenant or condition against the assigning, underletting, parting with possession, or disposing of land leased. However, the Ontario Court of Appeal recently held that this limitation does not preclude the tenant from obtaining equitable relief from the court.
In 1497777 Ontario Inc. v. Leon’s Furniture Ltd., [2003] O.J. No. 4108 (Ont. C.A.), the landlord sought to terminate the lease because the tenant failed to obtain the landlord’s consent, as required under the lease, when the tenant agreed to renew the subtenancy for a second renewal term. On the previous occasion, the tenant had obtained the landlord’s consent when renewing the subtenancy. Relying on St. Jane Plaza Ltd. v. Sunoco Inc. ("St. Jane") (1992), 24 R.P.R. (2d) 161 (Ont. Gen Div.), the lower court held that the tenant’s failure to obtain the landlord’s fresh consent did not entitle the landlord to terminate the lease.
The decision was overturned as the Ontario Court of Appeal was of the view that even if the subtenant’s use and identity remained the same, an earlier consent to a sublease was not a consent for all time. The case was rather easily distinguished from St. Jane, as that case involved the tenant seeking the landlord’s consent and the landlord unreasonably refusing, whereas in the present case the tenant never sought the landlord’s consent.
In deciding whether to grant the tenant relief from forfeiture, the court considered the limitations imposed by s. 20(7) and concluded that the provision "does not stand in the way of resort to the equitable jurisdiction of the court" as it "does not prohibit resort to another source of jurisdiction for relief." As such, a tenant may also be entitled to relief under the Courts of Justice Act. Section 98 of that Act states that "a court may grant relief against penalties and forfeitures, on such terms as to compensation or otherwise as are considered just." Therefore, it is important to remember that the limitations under the Commercial Tenancies Act are not necessarily exhaustive.
Forfeiture Considered an "Extraordinary Penalty," and Relief May Be Awarded on Terms
Generally speaking, forfeiture is not looked upon favourably by the courts as it is often considered to be excessive and unjustified. In these circumstances, tenants can generally avail themselves of relief, provided they comply with certain conditions.
In 1532120 Ontario Inc. (c.o.b. Queen’s International College) v. 1212763 Ontario Ltd., [2003] O.J. No. 4108 (S.C.J.), the tenant operated a private school from premises situated within a conventional multi-tenant office building. The lease specifically permitted the private school. However, the landlord terminated the lease because the tenant’s students caused serious disruptions in the building and to its occupants. The tenant sought relief from forfeiture. The court agreed that forfeiture of the lease in these circumstances was warranted, as there was ample evidence to support the alleged breaches. However, there was some concern about the fact that there were more than four years left on the term of the lease and the landlord was well aware of the intended use of the premises. The court considered whether the forfeiture would be disproportionate to the harm suffered by the landlord and ultimately decided to grant relief, which was conditional on the tenant employing full-time attendants to clean the washrooms and supervise the students.
In Nappy’s Inc. v. C & L Co., [2004] O.J. No. 2583 (S.C.J.), the tenant operated a chain of barbershops and entered into a five-year lease commencing on December 1, 2002. The following year, the tenant had two rent checks returned due to insufficient funds and on four other occasions was late paying rent. Problems persisted and in February 2004, the tenant was given notice of rent default. The notice stated that the tenant would have seven days to cure the default, although the specified deadline for payment was February 17, 2004, which was only six days later. On February 18 the tenant attempted to deliver its cheque but the landlord refused to accept payment. The tenant applied to the court for relief from forfeiture. The court held that forfeiture of the lease would be an extraordinary penalty to impose in the circumstances as the notice of default was deficient, which resulted in the landlord having terminated the lease four hours before it should have been entitled to.
Interpretation
Renewal Clause Leads to "Commercial Absurdity"
Courts have long adhered to the principle that in the construction of written instruments you may depart from the literal meaning of the words, if reading the words literally leads to an absurdity. Put another way, contracts should be interpreted to give business efficacy to the terms of the agreement. These principles were enunciated by the Ontario Court of Appeal in Holt v. Thunder Bay (City)(2003), 65 O.R. (3d) 257 (Ont. C.A.) and were once again recently relied upon in the case of 152592 Ontario Limited v. Canadian Tire Real Estate Limited, [2004] O.J. No. 1881 (S.C.J.).
The case involved a tenant who leased commercial premises for a two-year term with an option to renew for up to 25 years and develop the lands for use as a gas bar. The lease provided that if the option was exercised, the term of the lease was to be recalculated to commence upon the opening of the gas bar. The tenant exercised the option and began redevelopment but discontinued paying rent on the grounds that it was not obligated to pay rent until the gas bar opened for business. The court said that to excuse the tenant from rent payments for an indefinite period (possibly up to 25 years) while it enjoyed the use of the premises for its business ends would result in a "commercial absurdity." Since the clause only provided for the term of the lease to be recalculated and made no mention of the discontinuance of rent payments during the redevelopment phase, the tenant was obligated to pay rent during the redevelopment of the gas bar.
Use Restriction to be Considered in Assessing Fair Market Value
A similar interpretation problem was faced by the British Columbia Court of Appeal in Pacific West Systems Supply Ltd. v. B.C. Rail Partnership, [2004] B.C.J. No. 853 (C.A.), where it took the view that the parties to a lease could not have intended for the tenant to be put in the position of paying rent based on the value of the unrestricted use of land when the tenant was precluded from enjoying this unrestricted use.
This case involved a disagreement between the landlord and tenant over the rate of rent to be paid under a periodic rent review clause. The clause provided that the rent shall reflect a fair market value on the date of the review. The lease restricted the use of the lands to the construction and operation of a building supply business. The question was whether the restriction should be taken into account in determining the fair market rental of the land in the absence of any provision in the lease.
The court relied on the judgment of the English Court of Appeal in Basingstoke and Deane Borough Council v. Host Group Ltd., [1988] 1 All E.R. 824 (C.A.), and held that under a rent review clause, in determining the fair market value of lands that are subject to a lease that restricted their use, the restriction is to be taken into account.
Tenant Entitled to Verify the "Reasonableness" of Common Maintenance Expenses
It is common for the tenants of a shopping complex or mall to be required to pay additional rent for the proportionate share of costs associated with the maintenance of common areas. Many commercial leases require that the landlord provide the tenant with reasonable evidence of such expenses. What is reasonable in the circumstances is often a matter of interpretation. In 94125 Ontario Ltd. v. A&P Properties Ltd., [2003] O.J. No. 4710 (S.C.J.), a dispute arose concerning the amount of additional rent payable under the lease. The lease provided that "the landlord shall furnish to the tenant an audited statement of additional rent stipulating in reasonable detail supported by such evidence in verification thereof as the tenant may reasonably require, the additional rent payable by the tenant."
At arbitration, the landlord maintained that it was only required to provide the tenant with its audited financial statements. The tenant argued that it was entitled to background information in order to verify that the additional charges were reasonable. The arbitrator held that by supplying boxes of material that cannot be analyzed and allocated, the landlord had not complied with its obligations under the lease. "It was not good enough to simply say the charges are reasonable without backup of any kind."
On appeal, the court agreed and further stated that if the landlord chooses to transfer its obligations under the lease to a third party, then the third party is required to provide the verification information to the tenant.
Use Clauses and Restrictive Covenants
"General Retail Merchandising" Does Not Include "Services"
In Goodman Rosen Inc. v. Sobeys Group Inc., [2003] N.S.J. No. 313 (C.A.), the Nova Scotia Court of Appeal was recently faced with the issue of whether a clause in a lease constituted a restrictive covenant and whether the tenant was in breach. The tenant operated a supermarket and entered into a lease that provided that the tenant was to "use the premises only for the retail sale of a complete line of food products, as well as general retail merchandising, as carried on by the rest of the majority of its stores." When the tenant decided to open a pharmacy in the supermarket, another tenant operating a drug store applied to the court for a permanent injunction preventing the pharmacy’s operation. The injunction was granted as the judge found that the professional services offered by a pharmacy did not constitute general retail merchandising.
On appeal, the supermarket argued that (i) the clause in question should be read as a positive obligation rather than a restrictive covenant, and (ii) its purpose was to set minimum standards for the store and compel the tenant to operate a top-of-the-line supermarket. The Court of Appeal felt that the clause was restrictive in nature and agreed with the lower court that "merchandise" is distinct from "services."
Court Defines "Convenience Store"
In Danyall Enterprises Ltd. v. Big Bear Food Ltd., [2004] O.J. No. 3371 (S.C.J.), a use clause in the tenant’s lease provided that the premises shall be used for the purpose of carrying on business as a "retail convenience store." The tenant operated its convenience store in a small commercial plaza and sold, among many other things, freshly prepared sandwiches. Quiznos, a submarine sandwich franchise operator, was another tenant in the same plaza. Under the Quiznos lease, Quiznos had the exclusive right in the plaza to engage in the sale of "delicatessen and submarine-type sandwiches." The landlord applied to the court for a declaration that the convenience store did not have the right to sell sandwiches.
The court concluded that the business of a convenience store includes the business of selling fresh sandwiches. In reaching this conclusion, the judge defined a convenience store as "a smaller store, usually open long hours, that sells to the public a wide variety of products and services, but that has a limited selection of services to choose from in each product line." It was further held that there is no difference between a variety store and a convenience store.
Restrictive Covenant Not a Restraint of Trade
Often, when rent is calculated as a percentage of gross revenue, the lease will contain a provision that prevents the tenant from "revenue splitting," that is, preventing the tenant from dividing its business into different parts in order to reduce its gross revenue and percentage rent responsibility. The courts are unwilling to say that a clause of this nature offends public policy as being a restraint of trade. In Vanreal Properties Limited v. Erisan Inc., [2003] O.J. 4701 (Ont. Sup. Crt), a clause in a lease stated that "the tenant shall not directly or indirectly own, participate in, lend money to or furnish any financial aid…to any business…within the permitted radius which is in any manner or degree competitive with the business carried on in the leased premises." The lease provided that if the tenant breached this covenant, then the landlord could add all revenue from such competing business to the tenant’s gross revenue and consequently, the tenant would be required to pay percentage rent based on its total gross revenue. The Court held that a restrictive covenant that prevents revenue splitting is a common feature of leases in Ontario and it would not offend public policy either because of its nature or its breadth. In the Vanreal case, however, the Court held that separate corporate entities of the companies operating the two stores in question made a finding of breach of the restrictive covenant unsustainable. There was no evidence that the tenant provided any assistance or support to, or participated in, the business of the other store. Miscellaneous
Option to Renew
In 138421 Ontario Inc. v. Ole Miss Place Inc., [2003] O.J. No. 3752 (C.A.), the Ontario Court of Appeal recently held that a landlord has no obligation to give notice of a tenant’s default before relying on that default to refuse renewal of the lease. The tenant operated a tavern in the landlord’s multi-unit building. On several occasions, it was alleged that the tavern over-served its patrons until they became so intoxicated that they would damage property and harass other tenants around the building. The lease contained a renewal option that was exercisable, provided the tenant was not in default. The tenant attempted to exercise the option but the landlord refused, taking the position that the tenant was in default as a result of the over-serving. The tenant brought a successful application for a declaration that it was entitled to exercise, and had validly exercised, its lease renewal. The application judge held that the landlord had not given notice of the breaches prior to the tenant’s renewal.
The Court of Appeal overturned the decision and held that there was no obligation under the lease to give notice of any alleged default and there was no such obligation at law. Further, the fact that the landlord continued to accept rent after delivering its notice of termination did not bar it from refusing to renew the lease. Acceptance of rent after known breaches was relevant to the landlord’s right of forfeiture; however, forfeiture related to the right of the landlord to terminate an existing lease term, not the option to create a new lease term.