MAPLEVIEW V PAPA KEROLLUS: ERRING ON THE SIDE OF FAIRNESS WHEN ADJUDICATING COMMERCIAL LEASES

Mapleview-Veterans Drive Investments Inc. v Papa Kerollus VI Inc. (Mr. Sub)2016 ONCA 93 [Mapleview], a case released yesterday by the Ontario Court of Appeal (“ONCA”), is the latest pronouncement on interpreting commercial lease provisions. While the outcome of the appeal is understandable given the facts relied upon by the parties, it causes concerns not only for how future cases will be interpreted, but also for the bargaining power it bestows onto commercial landlords at the expense of fairness for commercial tenants.

The case centres on the contractual right of Papa Kerollus VI Inc. (the “Tenant”) to elect to renew the lease for an additional term by a certain deadline. In this case, the contract stipulated that the tenant must comply with several pre-conditions to be eligible to exercise this right. A key pre-condition was that any “additional rent” due under the agreement could not be in arrears. Feeling like Mapleview-Veterans Drive Investments Inc. (the “Landlord”) was improperly accounting for additional rent due and unfairly demanding higher payments in an attempt to squeeze it out, the Tenant disputed the amount due. In turn, the Landlord held the Tenant to be in default and denied its right to renew on that basis. While the applications judge was sensitive to the circumstances of the alleged default, the ONCA found the dispute to be irrelevant for determining whether the pre-conditions to exercising the renewal option had been met. In doing so, it further opened the door for future landlords to demand unreasonable amounts from their tenants, knowing that even a legitimate dispute by the tenant could not preserve its ability to hang on to its lease and continue operating its business. This in turn could lead to increased predatory conduct towards less sophisticated commercial tenants.

Issues and Reasoning

Although the Landlord in this case denies having an agenda to, in effect, get rid of the Tenant at the end of the lease, the facts of the case more than point in that direction. In any event, the facts depict a long-standing dispute implicating distrust of the Landlord by the Tenant and suspicion of bad faith conduct.

Of key importance is the wording of Clause 2 in the lease, which states: “provided that the Tenant had paid the rent and all other sums payable under this Lease when due and, provided the Tenant has performed all other covenants under the Lease as and when the same are required to the performed, the tenant shall have the option to renew for one further term of five years.”

The issue at the lower court and at the ONCA was whether the Tenant complied with the above clause with respect to paying the “additional rent” due under the agreement, which consisted of the Tenant’s percentage share of taxes, maintenance, and insurance (“TMI”). As mentioned, these amounts were disputed by the Tenant on the basis that its percentage of TMI was not being accurately allocated and that the Landlord was attempting to collect an unreasonable amount for these costs in advance.

The applications judge in the lower court acknowledged the relevance of the dispute to whether the Tenant was able to comply with the pre-conditions set out in Clause 2 of the lease. He ultimately held that once a judicial determination of any arrears owing was made, the Tenant would have 60 days to pay—at which point the pre-conditions in the clause would be satisfied, allowing the Tenant to validly elect to renew the lease. The applications judge concluded at para. 40 of his decision that “a tenant is entitled to know with some degree of accuracy what arrears exist, so that it can put itself in a position where it is not in default when exercising its renewal right.” In effect, he found that compliance with the clause was in some cases contingent on the Landlord and Tenant agreeing on the quantum of what those preconditions are, in this case the existence of any arrears.

The Court of Appeal took a completely different approach. It held that the applications judge erred by giving any relevance to this dispute and that the only issue was whether the arrears demanded at the time was paid by the Tenant or not. It based this holding on other clauses in the agreement, namely clauses 3.C. and 10 through 13, which required the Tenant to make percentage payments towards TMI on a monthly basis and “upon demand” after receiving the Landlord’s estimate. Thus, as long as the Landlord made a demand for the funds pursuant to this provision, the Tenant must pay in order to avoid defaulting on the lease and losing its renewal right despite disputing the amount demanded. The ONCA likened this contractual provision to a promissory note that gives the holder an undisputed and unassailable right to the value of the note plus any interest

A Difficult Predicament

Some important context here is that commercial landlords have the ability to evict a commercial tenant at the end of a lease and gain possession of the leased premises. This is the case regardless of whether the tenant is conducting a viable business and wishes to continue. In some cases, predatory landlords have refused to renew a lease to a successful business, forcing it to leave. They have then occupied the space to operate the business under a new name or have re-leased the space at a premium, exploiting the former tenant’s leasehold improvements and customer base. While this occurs more frequently in the retail context, tenants typically negotiate a renewal clause to protect themselves against such a scenario.

Being in a position to make findings of fact and to assess credibility, the applications judge understood the dynamics of the scenario that had unfolded. He understood the near impossible predicament the Tenant was placed in and the ability of the Landlord to make continuous and escalating demands for more money under the agreement.

While the Court of Appeal took a strict and literal approach to interpreting the provisions in the agreement, it reached the right decision given the fact scenario at hand.. The decisive factor was that the Tenant admitted to owing a small undisputed sum of principle rent, less than $300.00. The Court commented that the provision in Clause 2 of the lease cannot be interpreted as permitting the Tenant to pay almost all of “the rent and all other sums payable under this Lease when due.” It was required to pay every penny. Fair enough.

However, in principle, the court went much further than this. The broader principle evolving from this decision is concerning, especially since the case could have been decided alone on this small undisputed rent sum. The Court went as far as holding that the existence of any dispute is irrelevant and that a tenant is required to pay any amounts demanded by the Landlord to avail itself of the renewal clause. Not only is this is rather harsh, but it is problematic because the real issue is the proper interpretation of the clause that permits the Landlord to make demands for increased payments and in turn obligates the Tenant to pay them. The ONCA’s Promissory Note analogy in this case fails because, unlike the note, the quantum of what is due and payable is not established as it is on the face of the note. For the purpose of reaching a fair decision, the ONCA should have interpreted the limits of such a clause; after all, it had relied upon it in principle. It is unclear whether such clauses in the context of commercial lease agreements truly entitle the Landlord to demand whatever it wishes, especially when its goal is to get rid of the tenant and re-lease the space or continue the Tenant’s business. Surely, such ‘on demand’ clauses are attached to other provisions in the lease and are subject to considerations of fairness, reasonableness, and good faith. For example, if the Landlord anticipates that the cost of TMI is going to rise in the upcoming year, it would be properly entitled to demand higher payments towards TMI and credit any overpayments back at the end of the period in question. However, what if the Landlord demands three times its anticipated cost increase, leading to a dispute between itself and the Tenant? Taking a strict and literal interpretation of the right to make demands under the lease fails to articulate any constraints on the exercise of such a right.

Conclusion

By ruling that issues around the satisfaction of preconditions to exercising rights in commercial leases are essentially not disputable, the ONCA further opened the door for future landlords to behave unreasonably towards their tenants, precluding them from exercising key contractual rights such as the right to renew. This in turn could lead to increased predatory conduct towards less sophisticated commercial tenants. The ONCA could have endeavoured to interpret the “on demand” clause in the lease and articulated some parameters of reasonableness and fairness. This approach could better balance the contractual rights of landlords and tenants in the commercial leasing context.

Author
farkas

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