In Deslaurier Custom Cabinets Inc. v. 1728106 Ontario Inc., the Ontario Court of Appeal recently handed-down an important decision which adds clarity to the ambiguous relationship between a tenant’s obligation to carry insurance and a landlord’s obligation to indemnify the tenant for damages. In its ruling, the court also held that, when interpreting the scope of an indemnity covenant, a tenant is not permitted to venture outside of a defined term in the lease.
The landlord and tenant entered into a lease dated November 28, 2007 for premises in a commercial building. The tenant used the premises to operate a business manufacturing and selling custom cabinets.
The lease contained the following provisions:
- The tenant was responsible for securing insurance coverage for all risks of loss or damage to its property and business interruption loss.
- The tenant was required to add the landlord as an “additional insured” to its insurance policies.
- The tenant was required to indemnify the landlord against all claims for damage to person or property.
- The tenant was not entitled to claim against the landlord for damage caused by fire.
- The landlord covenanted to indemnify the tenant against damages to the premises caused by any act, default, or negligence of the landlord.
The tenant fulfilled its obligation to insure. However, despite the terms of the lease, it failed to add the landlord as an additional insured to its policy.
On January 1, 2009, the landlord undertook certain welding work at the premises, which caused a fire that resulted in significant damage to the premises and the eventual demolition of the building.
The tenant made a claim to its insurer and received over $10 million in compensation. However, the insurance proceeds were not sufficient to cover all of its losses. The tenant then commenced a claim against the landlord and the welding company for the balance of the uninsured loss, including for damages to the tenant’s property and business interruption losses, in the amount of $4,138,114.
The Superior Court Decision
The landlord brought a motion for summary judgment to dismiss the tenant’s action, and the tenant brought a cross-motion to determine the legal effect of relationship between the indemnity clause and the insurance clause in the lease.
The landlord argued that the tenant’s obligation to obtain insurance against fire relieved it of any liability. The landlord pointed to a trilogy of Supreme Court of Canada cases which held that parties to a contract responsible for obtaining insurance assume the risk of damage or loss caused by an insured event. The landlord also claimed the tenant was in breach of its obligation to add the landlord as an additional insured, and had it done so, it would have precluded a subrogated claim being pursued against the landlord.
The tenant argued that the obligation to insure on which the landlord relied was limited by the indemnity provision in the lease which expressly required the landlord to “keep the tenant indemnified against all claims with respect to any damage to the Premises arising from the act, default, negligence of the Landlord”.
Moreover, the tenant also claimed that the reference to “premises” in the indemnity provision must be read to include the property of the tenant, and that to interpret otherwise would render the provision illogical as it would indemnify the tenant for something in which the tenant had no interest. The tenant took this position despite the fact that “premises” was a defined term in the lease the explicitly referred to the rentable area and made no reference to the tenant’s property.
The motions judge ruled in favour of the tenant. In so doing, the court held that the initial step in interpreting an agreement is to interpret, to the extent possible, the contract as a whole and to give effect to all of its provisions, and that a literal meaning should not be applied where it would bring about an unrealistic result.
While the references in the lease to “premises” seemed to indicate that it referred only to the rentable area leased by the tenant, the court agreed with the tenant that this approach would, in effect, render the indemnity provision meaningless since the tenant has no interest in the premises itself.
The court went on to cite the Ontario Court of Appeal case of High Tech Group Inc. v. Sears Canada Inc., which held that “because words always take their meaning from their context, evidence of the circumstances surrounding the making of a contract has been regarded as admissible in every case.” The court then referred to extrinsic evidence in the form of leases for other units in the same building, which, unlike the lease in question, contained a one-way indemnification clause, requiring only that those tenants indemnify the landlord. The court concluded that this was a strong indication that, objectively, the parties must have specifically intended to give the landlord some contractual right not granted to the other tenants in the building, which would logically prevail over any “standard” terms routinely included in the other leases. The court found that the landlord’s indemnity in favour of the tenant was intended to limit the tenant’s obligation to insure.
The court then considered the effect of the tenant’s failure to add the landlord as an additional named insured and the landlord’s assertion that this omission barred any claim the tenant may have had against it since the landlord would have been an “insured” and an insurer cannot sue his own insured. The court held that there was insufficient evidence to support the landlord’s claim that the insurer was not allowed to sue its own insured.
Accordingly, the court held that the landlord was liable for the tenant’s loss. The landlord had undertaken to indemnify the tenant with respect to damages to the premises (including the tenant’s property). The court found that this provision modified the landlord’s protection from liability and the covenant to insure did not excuse the landlord from liability resulting from its acts or negligence.
The motions judge’s decision became the subject of concern among commercial landlords. The decision made it difficult to unravel the interplay between indemnity clauses and provisions which obligated a tenant to insure. It also raised concern insofar as it seemed to limit the effect of a tenant’s obligation to insure, which usually acts as waiver of liability in favour of a landlord. The motions judge’s refusal to place any weight on the tenant’s failure to add the landlord as an additional insured also drew critical ire.
However, most notably, many found the motions judge’s interpretation of the term “premises” to be quite perplexing. This was especially difficult to accept because, in expanding the meaning of “premises” to include the tenant’s property, the motions judge went outside the boundaries of a defined term in the lease.
The Court of Appeal Decision
The Ontario Court of Appeal recently overturned the motions judge’s decision and accordingly granted the landlord’s motion to dismiss the tenant’s claim. In its ruling, the Court of Appeal dealt with each aspect of the decision separately.
The Obligation to Insure took Precedence over the Indemnity Covenant
It was held that the motions judge erred by ruling that the landlord’s indemnity covenant took precedence over the tenant’s obligation to insure, thereby making the landlord responsible for the damages to the tenant’s property caused by the fire. The court stated that the motions judge’s ruling was made in error insofar as it failed to properly apply the governing case law and principles of contractual interpretation in assessing the juxtaposition of the contested provisions in the lease.
As such, by agreeing to insure against all risks of loss or damage to its property caused by fire, the tenant had assumed all such risk and therefore relieved the landlord from the risk of liability, even when caused by the landlord’s negligence. The motions judge therefore failed to interpret the tenant’s insurance covenants in a manner that properly recognized the parties’ agreed allocation of risk.
Interestingly, the court also mentioned that the tenant’s insurance did, in fact, pay out in full. Therefore the shortfall claimed against the landlord was the result of the tenant failing to carry sufficient insurance coverage. In this regard, the court stated that “[t]he fact, as it happens, the Tenant was underinsured for this risk does not mean that its failure to obtain full protective coverage can be laid at the Landlord’s door”.
The use of the term “premises”
It was held that the motions judge erred in holding that the term “premises” in the landlord’s indemnity covenant included the tenant’s property. The court cited numerous reasons for this error. First, the interpretation accepted by the motions judge ran afoul of the fact that the word “premises” was a defined term in the lease, which made no mention of the tenant’s property. Second, there were multiple provisions in the lease which clearly distinguished between the “premises” and the tenant’s property. In fact, the tenant’s insurance covenant explicitly made this distinction. Third, contrary to the motions judge’s reasoning, the tenant did have an interest in the rented “premises” without including its property by virtue of the fact that the tenant was given exclusive use and occupation of the rented space under the lease.
The court also noted that, if the landlord’s indemnity covenant applies to damage to the tenant’s property by expanding the use of the term “premises”, then there would be no need for the requirement in the lease for the tenant to carry insurance to cover the risk of fire damage to its property.
The Extrinsic Evidence
As for the admission of extrinsic evidence pertaining to other leases in the building, the court of Appeal held that this was an error on the part of the motions judge. In this regard, the court noted that, in like circumstances, the case law holds that extrinsic evidence may be admissible in interpreting the terms of a contract, but such evidence “must never be allowed to overwhelm the words of that agreement” and cannot be used “to deviate from the text such that the court effectively creates a new agreement”. Accordingly, even if the extrinsic evidence was admissible, the contents of the other leases do not control the proper interpretation of the lease at issue because they neither establish nor alter the agreed upon allocation of risk in this lease.
The Failure to add the Landlord as an “Additional Insured”
Finally, the Court of Appeal held that, contrary to the motions judge’s ruling, if the tenant had added the landlord as an “additional insured”, as required by the lease, this would have indeed operated as a bar to subrogated claims against the landlord. As such, had the tenant complied with its obligation, it would not have a viable subrogated claim against the landlord for loss or damage to its property arising from the fire. The tenant therefore could not benefit from its breach of the lease.
The Court of Appeal’s ruling has provided some comfort to commercial landlords who became concerned about the unclear limits of a tenant’s obligation to insure. It also serves as a cautionary tale for tenants to carry sufficient insurance coverage, because they may face difficulties in claiming against a landlord to make up for a shortfall in damages paid by their insurers. And, most notably, the Court of Appeal also provided assurance to landlords and tenants alike that, when interpreting a lease, a court should be wary about venturing outside the boundaries of its defined terms.