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Practise avoidance

Real Estate
|Written By Marg. Bruineman
Practise avoidance
Illustration: Pete Ryan

Like many relationships, the one between a commercial landlord and tenant could come to a much happier, simpler conclusion if precautions are taken beforehand.

When a commercial lease is at an end, the tenant can still be liable to the landlord for damages. If the landlord isn’t satisfied with the state of repair of the property, the relationship could quickly disintegrate. What’s key, says Jamie Spotswood, is paying attention to the obligation usually contained in commercial leases for the tenant to leave the premises in a good state of repair, which usually allows for an exception for reasonable wear and tear. But it’s not always so straightforward.

Spotswood refers to the roof of a leased building that needs replacing just as the tenant’s term comes to an end as an example of where interpretations of wear and tear could differ. “It is up for debate whether a tenant should be at least partly responsible for the cost of replacing the roof (that comes to the end of its life toward the end of the term of a lease). If however, the tenant leaves the roof unrepaired or makes inadequate repairs to the roof during the course of the tenancy, which result in further damage to the property, the cost of repairing the damages will be for the tenant’s account in most cases,” says Spotswood, who practises commercial real estate law with Lenczner Slaght Royce Smith Griffin LLP. “The important thing is to make sure when the lease expires there’s communication between the landlord and tenant. It’s good for the landlord to have a look before . . . and alert the tenant to any problems.”

The terms of the lease and the intended use of the property are the starting points for the standards that apply, he adds. The Ontario Court of Appeal referred to the following wording, in part, within the lease when coming to a conclusion in 2004’s Stellarbridge Management Inc. v. Magna International Canada Inc.: “The manner in which the demised premises shall be maintained shall be at the sole discretion of the lessor provided that the said manner shall be reasonable and in keeping with the maintenance of a first class industrial building having regard for the then age of the building.” The landlord’s argument that the tenant was obliged to return the leased premises at the end of the term to a brand new, pristine industrial building was rejected. “The reasonable wear and tear of an industrial facility will differ from that of an office building and so the permitted use of the premises becomes relevant to assessing the reasonableness of the exception,” says Spotswood.

Problems at the end of the term can be avoided if the elements that may well be of concern to the landlord can be addressed right at the beginning. Anticipating the possibilities at the start of the relationship can go a long way to avoiding conflict down the road. The landlord can also build in some protection by having a good record on the condition of the premises at the beginning of the term.

For an existing property Adam Merrick suggests it is important during lease negotiations that the landlord and tenant agree on a standard of repair, setting out the parametres of repair including any exception regarding reasonable wear and tear, spelling out the tenant’s responsibilities and diffusing any future disputes. Doing a property inspection together and chronicling the state of the property through video and photographs can also be part of that process. “The parties have to be on the same page,” says Merrick, an Edmonton-based partner at MacPherson Leslie & Tyerman LLP who has just completed his term as co-chairman of the commercial property and leasing subsection of the Canadian Bar Association — Alberta.

In Canada the standard of repair is typically measured at the start of the lease. So knowing what the condition of the premises is at the beginning of the term and having a record of it goes a long way to determine what the necessary condition should be at the end of the term. Although the tenant is not held to a standard of perfection — that’s where the exception of reasonable wear and tear comes into play — each situation is fact specific.

Merrick says negotiations at the start of the lease should cover various items and avoid vague references, ensuring the tenant’s obligations are clear. “The parties should set out in the lease what the requirements of the repair are or are needed and set out exactly what that means,” such as listing defects, he says. “They can contractually have control at the start of the lease and lay it out.” Darrell Gold, a partner at Robins Appleby LLP who leads the leasing component of its real estate group, says, “Being proactive is, ultimately, cheaper than being reactive.” Developing a baseline of both the property’s land and the buildings at the start of the lease allows both parties to refer back when the lease ends to determine if, or to what extent, the property has changed — either through improvements, damage, or deterioration.

Coupled with establishing the baseline property condition, he notes leases typically provide landlords with a right to inspect the property from time to time. Those inspections are an opportunity for the landlord to identify issues before they develop into larger problems. While there is always some wear and tear, if there are concerns, the landlord has the onus of proving there is damage.

It’s then up to the tenant to prove the damage was a result of reasonable wear and tear.

A security deposit can help the landlord reduce its exposure to damage repair costs, but Gold points to 1299746 Ontario Inc. v. 784481 Ontario Inc., which found a landlord couldn’t use the security deposit since the lease referred to the tenant’s obligations during the term, not end-of-term obligations like restoring the premises. The lesson, says Gold, is to incorporate language into the security deposit clause to include both during and end-of-term obligations.

A problem may occur, however, if the security deposit is confused with last month’s rent. For many, they are considered as one. But that one payment may well be used for last month’s rent, leaving nothing for security. So there is no money left to draw to cover the costs of damage caused to the property by the tenant. “The lease should provide for a rent deposit for first and last month’s rent in addition to a security deposit,” says Gold.

Often, it is dependent on the leverage either the tenant or the landlord has. A large retail client may not agree to providing both a security deposit and the last month’s rent, but there are situations where it can be negotiated, says Natalie Garton, a solicitor with the Vancouver, B.C., commercial real estate firm Terra Law Corp.

The security deposit also doubles during the course of the lease term for both financial default and non-financial default. So if the tenant doesn’t pay rent within the subscribed period or if the landlord sees damage that needs to be repaired, the landlord can use money from the deposit. “With a deposit clause you’ll want the ability to use that,” says Garton. If it is used, the tenant is obliged to replenish the deposit to cover possible defaults throughout the remainder of the term or at its conclusion, she adds.

Louise Boutin typically represents tenants in her real estate work with Langlois Kronström Desjardins LLP’s Montreal office and often finds herself searching for the intent of the lease at the end of a term, particularly a lengthy one. Sometimes, she says, negotiations are required at the conclusion of the relationship to clarify the responsibilities of both the landlord and the tenant to contain conflict.

She has come across leases dating back to the 1960s that, over the years, have been renewed, extended, or are adopted when a new company assumes existing leases, as Wal-Mart did when it took over former Woolco premises in Quebec. Or a landlord might use a standard lease. “Either the parties come up with a proposed solution, or then end up in litigation. . . . Because we’re talking about a negotiated contract, who can change that contract is the same two parties,” she concludes.

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