The following scenario is common in the commercial leasing world:
A landlord delivers an invoice to a tenant for additional rent owing. The tenant disputes the amount claimed by the landlord and refuses to pay the invoice. The tenant subsequently decides that it wants to exercise an option to extend/renew its lease for an additional term. However, the lease requires that the tenant not be in default at the time it exercises its option. The tenant delivers notice to the landlord of exercise of its option to extend; in response, the landlord claims the tenant is in default under the lease (i.e. one of the preconditions to the exercise of the option has not been satisfied) and therefore the tenant is not entitled to the option. What should a tenant do in these circumstances?
Based on the guidance offered by a recent Ontario Superior Court decision, the best course of action to preserve an option to extend the lease is to pay the disputed amount under protest and commence a court action to address the dispute.
McRae Cold Storage Inc. (the “Tenant”) leased space in a cold storage warehouse from Nova Cold Logistics ULC (the “Landlord”). The rent payable under the lease was a “gross” amount, meaning that the stated rent included utilities. The lease provided that “[the Landlord] shall pay all fees and charges for water, gas, electricity and sewer use at the Demised Premises in connection with [the Tenant’s] use of the Demised Premises”.
The lease also stated that “[n]otwithstanding anything to the contrary set forth herein, the parties expressly agree that in the event any energy supplier increases [the Landlord’s] cost of energy at the Warehouse Premises in excess of three percent (3%) of the current electric rates during the Term, then [the Landlord] reserves the right to pass through said increase on a pro rata basis to [the Tenant], based on the proportionate amount of square footage of the Demised Premises to the square footage of the entire Warehouse Premises” (the “Energy Provision”).
The renewal right stated that “[i]f…[the Tenant] is not in default under any terms of this Lease…[the Tenant] shall have separate options to extend the term of this Lease for two (2) additional consecutive terms of five (5) years each” (the “Renewal Option”).
From 2013 to 2016, the Landlord did not pass through any increases in energy costs to the Tenant. In 2016, the Landlord informed the Tenant that, in accordance with the Energy Provision, the Tenant was required to pay a portion of increased energy costs.
The Tenant disputed the Landlord’s interpretation of the relevant provision and refused to pay the increased energy costs.
The Landlord sent the Tenant a notice of default and claimed that, since the Tenant was in default of the lease, the Tenant was not entitled to exercise the Renewal Option.
The Tenant nonetheless delivered a notice exercising the Renewal Option. The Landlord rejected the notice and maintained its original position regarding the Tenant’s default.
The Tenant commenced a court application seeking a declaration that it was not in default of its obligations under the lease and that it had properly exercised the Renewal Option. The Tenant also brought a motion for an interlocutory injunction seeking to preclude the Landlord from exercising its right to terminate the lease.
The Tenant argued that since the lease was a gross lease, no additional amounts were owing by the Tenant to the Landlord. The Tenant also argued that the principle of contra proferentem should apply. Contra proferentem is a principle of contractual interpretation which holds that an ambiguous clause should be interpreted against the party that drafted the document; in this case, the Landlord.
The Court held that the principles of contractual interpretation required the Court to give meaning to all of the terms of the lease and to avoid an interpretation that would render a term ineffective. The Court found that although the Energy Provision was flawed, it was not so ambiguous as to be devoid of meaning. It concluded that the Energy Provision was not inconsistent with the “gross” nature of the lease. The Landlord remained responsible to pay for the utilities, including the bulk of the electricity costs; however, the Court found that the parties specifically agreed that the risk of a significant rise in electricity costs could be passed on to the Tenant.
The Court also found that the principle of contra proferentem did not apply because the Energy Provision had an ascertainable meaning and the lease was negotiated between two commercial parties, each of whom had been represented by an experienced real estate broker.
Since the Tenant did not pay any of the increase in energy costs billed to it, as required by the Energy Provision, the Court determined that the Tenant was in default of the lease. The Court concluded that, while the Tenant may have disagreed with the Landlord’s interpretation of the lease, it was not open to the Tenant to refuse to pay. The Court held that the Tenant should have paid the amount demanded, while reserving its rights to bring an application for an interpretation of the lease.
Since the Tenant could not demonstrate that it had complied with the preconditions required for its exercise of the Renewal Option, namely, that it was not in default when the notice of renewal was sent, the Court found that the Tenant was not entitled to exercise the Renewal Option.
Lease options often contain pre-conditions stipulating that the tenant not be in default under the lease at the time of exercising the option. When a tenant is engaged in a dispute with its landlord at the time it wishes to exercise an option, the first question it needs to consider is: am I potentially in default under my lease? Tenants should avoid any scenario where they could be found to be in default, even if that means paying a disputed amount of rent under protest. Generally, it’s not a wise idea to stand on principle if the implication is that, by doing so, a default has been committed. Taking the high road by paying rent under protest is a much safer stance, as shown by McRae Cold Storage Inc. v. Nova Cold Logistics ULC.