David Hill may not have known it at the time, but he was playing a high-stakes game of poker when he sued the Toronto Catholic District School Board over a real estate deal gone bad.
The co-owner of Ballantry Homes was also a principal of Southcott Estates Inc., the single-purpose company created by the firm to purchase a parcel of land from the school board for a residential development. Southcott asked the court for specific performance of the breached agreement of purchase and sale, and hedged its bet with a claim for damages in the alternative. But when Southcott decided not to buy a replacement property, Hill unwittingly pushed all his chips into the middle of the table.
And while the trial judge liked his hand, awarding Southcott almost $2 million in damages, in October, the Supreme Court of Canada rewrote the rules and wiped him out, upholding the Ontario Court of Appeal’s decision to reduce the award to a nominal $1.
Hilary Book, a litigator with WeirFoulds LLP in Toronto, says any developer who claims specific performance without mitigating their damages is “going all-in.”
“They can win big, but they can also walk away with nothing,” she said at a recent event discussing the case.
In late 2004, Southcott arranged to buy the five-acre plot of surplus school property for $3.44 million, and forwarded a 10 per cent deposit. But the agreement was contingent on the board obtaining a severance from the City of Toronto’s Committee of Adjustment.
The board applied for severance, but failed to get it before the closing date and pulled the plug on the deal, returning Southcott’s deposit.
At trial, the judge found the school board breached its best efforts obligation to get the severance in time, but decided the property wasn’t unique enough to warrant specific performance. Instead, he made the $2-million damages award to compensate for the loss of a chance to make profits after finding the school board failed to show Southcott’s failure to mitigate was unreasonable.
But at the court of appeal, the unanimous three-judge panel decided the trial judge had set the bar too high for the school board, and ruled Southcott’s refusal to mitigate was in fact unreasonable. The appeal court judges pointed to 81 parcels of undeveloped land sold in the Toronto area between the time of the contract breach and the trial, including several comparable lots bought by Southcott’s parent company Ballantry, as evidence it could have mitigated its losses.
The Supreme Court concurred, and upheld the appeal court’s substituted $1-damage award.
“Those who choose the benefits of incorporation must bear the corresponding burdens,” Supreme Court Justice Andromache Karakatsanis wrote for the majority in the 6-1 decision. “Southcott is entitled to the benefits of limited liability, but it is also saddled with the responsibilities that all legal entities have. The requirement to take steps to mitigate losses is one such responsibility.”
Geoff Hall, a partner in the Toronto office of McCarthy Tétrault LLP, says that approach presents a problem for developers, where single purpose corporations are routinely created by parent companies for individual transactions, in order to insulate each separate project from the legal consequences arising out of another.
According to Hall, mitigating damages by bidding for replacement properties in the name of a company with a lawsuit already in progress constitutes a major gamble of its own.
“That to me is not a good way of operating,” Hall says. “You end up getting a whole bunch of liabilities attached that really apply to a prior transaction.”
Indeed, Southcott’s lawyer wouldn’t let Hill even consider the idea, according to his testimony at trial.
“Generally we wouldn’t buy anything in another company if it’s still involved in something,” Hill told the court. “I don’t need the headaches.”
Hall says the lone dissenting judge, Chief Justice Beverley McLachlin, produced a decision more reflective of the commercial reality in the development business. McLachlin highlighted the inconsistency of mitigation alongside a claim for specific performance. “It makes no sense for a reasonable plaintiff seeking specific performance to effectively concede defeat and buy a substitute property. The plaintiff could end up with two properties — one it wanted and one it did not,” she wrote.
The majority decision, Hall says, effectively leaves developers with two options when faced with an alleged contract breach. “Neither are very appealing. You either give up your legal right to sue, or you end up taking on legal risks that could be avoided by purchasing another piece of land with the same vehicle,” Hall says.
Despite the additional liabilities that come with mitigation, Irvin Schein, a litigator at Minden Gross LLP, says single-purpose corporations will remain an attractive vehicle for developers. “It helps developers to keep the accounting straight,” he says. “And it’s also valuable in terms of protection from the perspective of liability. The value of being able to approach projects with individual companies is still extremely high.”
Jonathan Born, a real estate lawyer with WeirFoulds, says plaintiffs without a parent company, or with more limited resources, should factor in its ability to pay for both the initial deal and a replacement property before pursuing specific performance, in case they should fall into precisely the trap identified by McLachlin.
“If you go forward with a specific performance claim, and then another offer is successful, you may not be in a position to complete the original transaction,” he says.
But Malinda Yuen, who practises litigation in Calgary with Davis LLP, says virtually no plaintiffs will end up in that position. The Southcott decision is a natural progression in a long line of Supreme Court decisions that have gradually eroded the availability of specific performance in real estate matters, she says.
Although they may not like the result, she says developers should accept it and welcome the certainty it brings to the rules of the game. Generally, Yuen says, specific performance claims are a lost cause for developers, and they should focus instead on mitigating their losses. “The natural outcrop of the decision is that you’re not entitled to specific performance for real estates investments, where the interest in monetary,” she says. “The land might be unique in terms of development potential, but it’s not unique in terms of what you’re after, which is money. Rather than holding out and getting tied up in years of litigation, the business reality says move forward.”
David Mandell, vice president at Urbancorp Development, says he is of the same view, and the Supreme Court decision only reinforces his position. “We’re in the business of making investments, which happen to be in real estate. A development parcel is not unique, it’s an investment,” he says. “If we don’t get one, we move onto the next one. We’re not emotional about it. It might be in a completely different location, but that doesn’t really matter. What matters is whether it’s a good investment or not.”
“There are tons of opportunities in Toronto,” says Mandell, whose company’s purchases include a number of school board properties. “We’ve been quite active, and I would never go for specific performance unless I was buying the CN Tower, or Union Station, or something like that.”
For those that insist on pursuing a specific performance claim without mitigating their losses, the Supreme Court majority leaves a small chink of light. “If the plaintiff has a ‘substantial justification’ or a ‘substantial and legitimate interest’ in specific performance, its refusal to purchase other property may be reasonable, depending upon the circumstances of the case,” reads the judgment.
Schein says a key lesson from Southcott is that plaintiffs should at least make an effort to find comparable properties. The search does not have to be fruitful, and a genuine failed attempt may even boost a specific performance claim, he says. “You don’t have an obligation to find something, but you have an obligation to look, and the obligation is a good-faith one,” Schein says.
Despite the risks involved, Book said some of her clients will still be determined to proceed with a specific performance claim, such as in cases involving the final parcel in a larger land assembly, or a long term land banking project. In those cases, she says there are ways to minimize risks before hitting the final table at trial. “By then it’s too late. They’ve already mitigated or not, and they’re taking this big gamble,” she said.
One strategy would see the plaintiff moving for a certificate of pending litigation on the land at issue. If the motion is dismissed, then the plaintiff gets an early warning that specific performance is unrealistic, and can focus instead on mitigation.
If it’s granted, the plaintiff can make a stronger claim at trial that it was justified in claiming specific performance. However, “it’s not necessarily a cure-all,” said Book, since the test for granting a certificate of pending litigation is much less rigorous than the test that would need to be satisfied at trial for specific performance. “One of the key factors on a CPL motion is whether the plaintiff has a reasonable claim to the interest in the land. But the test is whether there’s a triable issue. The court isn’t actually making a determination at that early stage about whether there actually is a reasonable claim,” Book said.
Alternatively, she said plaintiffs could move for summary judgment on the issue of the uniqueness of the land. “If you’re successful, you eliminate all risk because the court has made a judgment that the land is unique, and you’re entitled to specific performance if you’re successful in proving the breach of contract,” Book said.