Handling Commercial Vacancy Disputes

Even before the pandemic, commercial landlords and tenants had their disputes.

The Ontario Court of Appeal recently dismissed an appeal in Old Navy (Canada) Inc. v. The Eglinton Town Centre Inc., thereby affirming the Superior Court decision that denied declaratory relief to the commercial tenant, and a refund of rent they claimed they overpaid.

The case centred around the interpretation of the lease. The tenant, who is a major international commercial retailer, and a subsidiary of the largest specialty retailer in the U.S., claimed the lease was straightforward and unambiguous. Justice Quigley disagreed, and held that a co-tenancy provision relied upon by the tenant to occupy the premises without paying rent was not commercially reasonable.

Although this might seem like a simple conclusion, what complicated it was that there were a number of versions of the lease discussed between the parties. One of them had some terms on them in handwriting around co-tenancy provisions and rights, but this term never made it into the final document. Nobody knows whose handwriting it was.

This was the case for much of the agreement, which was negotiated over two decades ago. None of the individuals involved with its creation were known or available, except a single executive of the landlord. In a contractual interpretation case this scarce of factual details this particular witness proved particularly helpful, especially since the tenant had relied on renewal options subsequently over the years, without any significant negotiations between the parties since.

The lease included two important operating requirements, relating to the presence of key stores, and a percentage of stores being open for operation. The lease allowed the tenant to request a notice of the trade name and operating details of these other businesses, but the tenant only requested period listings of tenants in connection with lease renewal options, and not for the purposes of assessing the operating requirements.

The main point of the dispute was around the substitution of tenancy. One of the tenants of the mall was facing a well publicized bankruptcy, unrelated to this particular location. However, over 90% of the rest of the mall continued to have tenants.

A few years later, the tenant that was a party to this action claims they found out about the bankruptcy, and indicated to the landlord that they would be relying upon an alternate rent remedy under the lease. The landlord disputed this position, and proposed an alternative tenant for the vacated space. After finding an alternative tenant, the party simply refused to respond. They also subsequently failed to respond to an invitation to a meeting to resolve matters prior to commencing any legal action.

Justice Quigley applied a commercial construction to interpret the contract, applied objectively in accordance with commercial principles and good business sense, avoiding a commercially absurd interpretation. The contra proferentum rule favoured the landlord, as the commercial tenant had used their standardized lease.

The lease was ambiguous, unclear, and capable of alternative meanings. Indeed, even the positions of the tenant shifted during the proceedings, based on the language of the operating requirements and tenancy substitution provisions. There was no clarity of a final common intention, and there unlikely was any such common intention at the formation of the contract,

[4] This decision focuses on whether the provisions of the Lease are clear, straightforward, and reflect the contract that the parties thought they had signed. It requires an interpretation of the Lease as well as an analysis of the parties’ contractual intent, their respective understanding of the Lease, and whether their dealings with each other were in good faith. With hindsight, in a contractual context, this dispute can be analogized to two ships passing in the night because neither the Landlord nor Old Navy ever had the same understanding of the Lease, and in particular, the Co-Tenancy Requirements.

[162] I reject GAP/Old Navy’s contention that as a consequence of this omission, the Landlord is now bound to accept rent that barely covered common area expenses. It is not a commercially reasonable position and offends the business efficacy rule of interpretation.

Justice Quigley also applied the good faith requirements from the Supreme Court’s decision in Bhasin v. HrynewWhile failing to make a meaningful appearance in the Court’s more recent decision in Matthews v. Ocean Nutrition Canada Ltd., this principle is still an important one for the interpretation of commercial contracts.

The Court’s use of good faith in Churchill Falls (Labrador) Corp. v. Hydro-Quebec. illustrates the ability of the court to intervene and impose terms on contracting parties based on notions of contractual fairness. However, Justice Quigley did not find bad faith here, noting that the tenant had a reasonable belief that their conduct was correct, as was their interpretation of the lease, even if it made no business sense or was objectively unreasonable.

While reviewing the American jurisprudence on co-tenancy disputes, Justice Quigley noted there are no reported decisions on this in Canada. He identified a similar principle in both jurisdictions, concluding that penalty clauses are generally unenforceable, especially where a provision specifies a payment of an amount upon a breach that is unreasonable and not a genuine pre-estimate of the damages. These clauses have also been found in Ontario to be unconscionable.

Alternate rent and closure remedies have also been curtailed by the courts during insolvency to allow for restructuring. Justice Quigley pointed to the example in T. Eaton Co., Re, 1997 CanLII 12405, and more contemporary examples with Target.

Despite this, Justice Quigley did not find that these provisions presumptively unreasonable when assessed at the time of formation, because the size and the context of the penalty was still unknown,

[222] I have found that it was not commercially reasonable for GAP/Old Navy to expect to be able to occupy the premises for the balance of its existing Lease term, effectively without paying rent, merely because of a technical event that had no evident impact on its business operations.

[224] I found that this was not a commercially reasonable position. It flows from an interpretation that, in my view, violates the foundational principles of business efficacy and leads to an absurd result. Moreover, while the Landlord may be faulted for not catching the omission at the time the Lease was signed, Old Navy’s failure to include the reciprocal termination right that had been agreed would be included in the formal Lease document left the Landlord with no mechanism to avoid the problem from continuing indefinitely. This is a further reason why I have rejected Old Navy’s claim that any co-tenancy failure took place in the circumstances of this case. The ambiguity of the co-tenancy language cannot support Old Navy’s highly technical, but in my view, inaccurate interpretation of that provision.

During this pandemic, the number of businesses that continue to struggle increases. Some of those businesses have difficulty paying their lease, which may give rise to vacancies. These vacancies in malls and plazas may trigger their own contractual problems, all of which will give commercial landlords many headaches.

The real lesson here, especially as our courts deal with the backlog of cases, is that a complex commercial contract, no matter how simple it seems to you on your reading of it, may not be how the other party reads it. More importantly, it may not be how a court reads it from an objectively reasonable and commercially sound perspective.

The real commercially viable option is for parties to seek resolution without litigation, knowing the uncertainty of placing ambiguous, unclear terms before the court, capable of multiple meanings, increases the risk enormously. A good start is to respond to such inquiries for resolution at the outset.

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