Changing commercial property use
What are the post-COVID implications for landlords and tenants?
COVID-19 has had and will continue to have a massive impact on commercial tenancies in Ontario. On the retail side, many small businesses are closing, and those that remain open are downsizing for lack of revenue. For office space, the work-from-home culture has meant a significant drop in demand.
In fact, the Toronto Regional Real Estate Board (TRREB) reports that while lease rate increased by 16%, leasing activity fell by 37% and sales fell by a whopping 61.2% in Q2 2020 when compared to Q1 2019. It's fair to say that commercial landlords are scrambling to keep their good tenants. To hedge losses, some are trying to bring in alternative types of tenants, and others are going for a complete change of use of premises.
In many cases, the resulting rezoning plans will have a major impact on the remaining tenants and their businesses. This begs the question: Was this what the parties bargained for when they signed the lease?
As many landlords are forced to rethink what to do with their properties, both sides will have to keep in mind four important legal considerations.
Always start with the lease
Traditionally, the high demand for commercial spaces before COVID gave commercial owners an upper hand in negotiating contracts. That dynamic is shifting as more and more owners are now willing to make concessions on standard lease terms to woo tenants into empty spaces. Still, the starting point to analyze the parties' rights will always be the lease contract.
Consider, for example, whether the lease has a "demolition" or "redevelopment" clause. Depending on how they are drafted, "redevelopment clauses" give landlords the power to terminate the lease when there are plans to redevelop or rezone the leased building. On the other hand, landlords are precluded from terminating leases for anything other than demolishing the building when there are standard "demolition clauses" in the lease contract. Subtle variations in the layout and articulation of the clauses can significantly affect the parties' rights in such a situation.
Will rezoning breach the tenant's right of quiet enjoyment?
What if the landlord decides to demolish half of the mall to build high rises, which will take years to complete? Will the construction next door amount to a breach of quiet enjoyment? The answer will vary from case to case.
Leases normally include a "quiet enjoyment" clause that entitles the tenant the right to quietly possess and enjoy the leased property free from disturbance from the lessor. Even if the lease contains no such clause, Section 23(1)(1)(ii) of Ontario's Conveyancing and Law of Property Act automatically implies a "quiet enjoyment" covenant into every lease contract without any "trouble, denial, eviction, interruption, claim or demand" from the lessor. Not every disturbance will qualify as a breach. To establish a breach of the tenant's right of quiet enjoyment, the tenant must show that the lessor's interference is physical or direct, "substantial," "serious" or of "grave and permanent nature." In a 1998 ruling in 1039198 Ontario Inc. v Ash Pharmacies Inc., the Ontario Court of Justice felt that the vacancies created by the landlord's unnecessary renovations to the leased building and the bad publicity generated by the landlord's actions were not "substantial" enough to warrant a finding of a breach. In contrast, the court found a breach when the noise, dust and disruption emanating from a major construction project undertaken by the landlord disrupted a tenant's business in Bloor Street Diner Ltd v Manufacturers Life Insurance Co.
Will rezoning amount to derogation from grant?
Where rezoning alters the nature and character of the leased premises, the tenant may legitimately argue that the landlord has taken back, or derogated, its grant of the lease. To prove it, the tenant must demonstrate that some act by the lessor has rendered the premises substantially less fit for the purposes for which they were let. In other words, is the tenant detrimentally affected in using the premises to sell its products or do its business? As articulated in Country Style Food Services Inc v 1304271 Ontario Ltd., the general principle is that a lessor's grant is construed strictly against him. He retains no rights over the leased premises except by reservation in the lease in clear terms. Commercial owners must be careful before rezoning a commercial space if it will likely to change the nature and character of the leased premises in a manner that renders it unfit for its original anticipated use.
A final consideration is the discussions the landlord and tenants had before signing the lease. While verbal communications do not hold much weight in today's age, it is likely that representations were made by email. What promises did the landlord make looking out 5 to 10 years ahead? Are they covered by the "four corners" clause of the contract, or will they fall outside because of the principle of "collateral contract"? A detrimental reliance by the tenant on a pre-contractual promise made may make the landlord liable, and vice versa.
An ill-thought-out rezoning plan can cause significant harm to both the tenant's and landlord's businesses and can easily result in costly litigation. Some courts have even imposed an injunction on the lessor where a tenant alleges wrongful interference with its right of quiet enjoyment or where the lessor's renovation plans negatively and substantially impact the tenant's quiet enjoyment of the premises. The litigation may also result in significant claims in rent arrears, termination of lease, and damages for business loss and breaking the lease.
These risks make it worthwhile for a landlord to invest in a thoroughly and professionally considered rezoning/change in use plan, and for tenants to seek advice before it is too late.
This information is provided for general information purposes only and does not constitute legal or professional advice. No reader should rely on this information or any part thereof without obtaining legal or professional advice specific to their situation.