The economic downturn is putting huge pressures on commercial leases.
The demand for space is dwindling, as companies scale down their operations, reduce their workforce, and cut back inventories. Struggling retailers are looking for concessions from landlords. Property owners are squeezed for cash and many are worried that a lost tenant or a few rent defaults could put them out of business.
It’s a time of insecurity and anxiety — and therefore a time when all parties are acutely aware of their legal risks, rights, and obligations. Lease documents that may have been signed with scant attention in good times are now being scrutinized carefully, as some parties are concerned they can no longer meet the terms of their agreements and others want to enforce their rights. It’s a time when landlords and tenants look to lawyers and the law for advice and solutions. And it’s a time for lawyers to readjust and refocus their practices to deal with problems that seldom surfaced during the boom years of real estate.
This look at commercial leasing today examines the tensions lawyers are grappling with in Ontario’s highly stressed commercial leasing market, as well as a timely move to update the 19th century legislation governing commercial leasing in British Columbia.
Ontario: Landlords and tenants pulling on the lease
As an expert in commercial leasing and mediation, Harvey Haber now has an opportunity to exercise all his skills. As he and other real estate lawyers point out, today’s depressed market conditions are compelling many landlords and tenants to come up with new deals or compromises that will allow both to stay in business. “Once tenants realize they’ve got a problem, they should take their financial statements and meet with their landlords. They should say, ‘My problem is really your problem because if I go out of business you’ll be out your money,’” says Haber, a partner at Goldman Sloan Nash & Haber LLP in Toronto. “There’s nothing wrong with saying to the landlord, ‘I can’t pay you. Can we make a deal? If you want to go ahead and sue me, go ahead.’”
Tenants may well be surprised at how willing a landlord will be to negotiate, says Susan Rosen, a partner in the Toronto office of Gowling Lafleur Henderson LLP. She notes that landlords are not only anxious to keep their cash flow going, but are also concerned about the impact on other tenants if neighbouring businesses close shop. And, in today’s market, she adds, “there may not be other people knocking on the landlord’s door to take the space.”
So what kinds of deals are tenants striking up with their landlords? Robyn Kestenberg, a partner at Minden Gross LLP in Toronto, says she is seeing deals involving rent abatement and rent deferrals. She says some landlords are also making new arrangements concerning the security that they are requiring from tenants, allowing tenants to use trade fixtures, for example, to secure additional loan financing, even though this had originally been prohibited under the terms of the lease.
“It’s important for lawyers to recognize the business realities and be practical, rather than looking at the terms of the lease alone. The lease may give you legal rights, but, at the end of the day, it doesn’t necessarily give you the result your client is looking for,” says Kestenberg.
Rosen says some landlords and retail tenants are now making deals involving percentage rents. This hitherto seldom-used arrangement involves reducing rents so they cover the landlord’s basic costs with a proviso that the tenant will pay a percentage of sales as business picks up again.
Joseph Grignano, a consultant in the Toronto office of Blake Cassels & Graydon LLP, observes that sometimes tenants may do the math and come to the conclusion that they just can’t honour the terms of their lease. “I don’t want to be advocating defaults, but it’s really a cost-benefit analysis,” he says. In these circumstances, he adds, “the quickest, cheapest, best option” is for the tenants to figure out what the damages would likely be if they were sued for defaulting on the lease and cut the landlord a cheque for that amount.
Grignano also warns clients about the risk of “midnight moves.” He says trying to remove your inventory and other property from the building so your landlord can’t seize it is obviously illegal and could result in significant liabilities, not only for the tenant, but also for anyone who helps with the move.
While market conditions are forcing everyone to negotiate as much as possible, there are limits and there are situations where landlords would rather take the risk of looking for a new tenant than make a deal, says Kestenberg, noting that a frustrated landlord will sometimes tell her, “I’d rather have the space than have to deal with this guy anymore.”
British Columbia: A new lease on life for a moribund law
Commercial landlords or tenants in British Columbia who want to understand their rights and obligations will sometimes make the mistake of consulting the province’s Commercial Tenancy Act. But they soon realize they’ll need a lawyer to interpret this 112-year-old statute with its 200-word sentences and arcane references to obsolete terms such as “rentseck” or “rent of assize.” Unfortunately, the odds are that the lawyer won’t understand it either.
“It’s like The Da Vinci Code of B.C. statues,” says commercial leasing specialist Scott Smythe, a partner in the Vancouver office of McCarthy Tétrault LLP. He notes that the law still incorporates language and English legal concepts derived from feudal times. “It’s extremely antiquated and frankly impenetrable except maybe to a legal historian.”
Fortunately, it’s a law that lawyers can usually ignore, relying instead on the provisions of lease agreements. And that’s one reason why it has survived for so long without being significantly updated. But every so often a problem will occur that isn’t adequately addressed in the lease and the Byzantine rules of the ancient statue must be invoked.
“It’s very cumbersome. It doesn’t work well at all. And, the few times I’ve seen it used, the tenants usually manage to get out of enforcement procedures fairly easily by using the court system to delay proceedings,” says real estate lawyer Peter Anderson, a shareholder at Vancouver-based Boughton Law Corp., whose practice mainly involves representing landlords on commercial leasing matters.
That’s why Anderson welcomes an initiative by the British Columbia Law Institute (BCLI) to produce draft legislation that could be implemented as a new commercial tenancy act. So far, this project has produced a consultation paper containing 58 recommendations. The deadline for submitting comments on these proposals is March 31 and a final report is expected in June.
Richard Olson, chairman of the committee leading this initiative and associate counsel at Vancouver-based McKechnie & Co., says the committee has taken “a relatively conservative approach.” While doing away with obsolete provisions and updating the language of the statute, the proposals also clarify and expand upon the rights of tenants and landlords, introducing some changes designed to bring the law more in line with present-day legal principles and practices.
Olson says the proposed changes are designed to accommodate the most sophisticated landlords and tenants, who will generally spell out all their rights and obligations in complex lease documents, as well as the least sophisticated, who may rely on a handshake and a deal written on a paper napkin. This is accomplished by allowing landlords and tenants to opt out of various rights and obligations through the terms of their written contracts, he says, explaining that the proposals thus attempt to protect smaller landlords and tenants from “all the ills that might arise without interfering with the rights of those big enough to look after themselves.”
To a layperson, it would seem like stating the obvious to say that tenants have an obligation to pay their rent, but this is one of several basic conditions of a lease that are left implicit in the existing legislation and in common law. Similarly, the proposals call for explicit terms that will allow the landlord to regain control of the property if the rent is not paid and require tenants to pay for damages they cause, unless these damages are covered by the landlord’s insurance.
Smythe notes that the proposals also address some tricky issues arising from the historical differences between property and contractual law. Whereas a contract generally binds all parties to uphold all the terms of the contract, the various covenants in a lease have historically been considered to be independent of one another. So, for example, a landlord could be in breach of a contract if he doesn’t keep the building in good repair and the tenant may therefore refuse to keep his end of the bargain by paying rent. Under the historical interpretation of a lease, however, it could be argued that the tenant must still pay rent, even if the landlord fails to repair the building. The BCLI proposals try to resolve any uncertainties on this issue with a stipulation that “contractual principles apply” to rights and obligations under a commercial lease.
The consultation document also proposes a streamlined dispute resolution procedure to replace the cumbersome process involved in going to court over a breach or default in a lease. As Smythe explains, under the existing law, if a tenant is in default and refuses to leave the premises, the landlord must go to court to obtain a summons and the tenant can then challenge the summons, before substance of the matter is heard in court. The proposed new rules, however, simply involve making an application and then having both parties show up in court.
Under the streamlined process, Olson observes, a tenant who is complaining that a landlord has failed to plough the parking lot during a snowstorm may have a chance of seeing the matter resolved before the snow has melted.
Olson says members of his committee could not reach a consensus on what to propose with regards to the right of distress whereby a landlord is allowed to seize the property of a tenant who hasn’t paid the rent. One option is to abolish this right on the grounds that it is seldom used and can easily be abused. The other is to preserve it, but set clear rules on who can seize what property, when, and how.
In any event, it’s a right that landlords are usually reluctant to enforce because tenants who can’t pay their rent will probably also have other obligations, such as liens or tax arrears that will take precedence over their obligations to the landlord. However, as Smythe observes, the threat that a landlord may exercise this right “is a powerful incentive to tenants to pay their rent on time.”
Smythe believes that B.C. legislators will have the political will to implement the proposals once they are finalized. He says it would be a big mistake to pass up this opportunity to update an obsolete law. “Commercial leasing is an incredibly important part of the economy and to have a statute which is impenetrable and doesn’t address modern concerns isn’t very helpful,” he says.
Freelance journalist and business writer Kevin Marron can be reached at email@example.com