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The Lesson Learned from a Leasing Arrangement

In the previous installment, we reviewed a scenario when the lender can attorn rents and the tenant has to pay rent to the lender. Assuming that the tenant and lender have a non disturbance agreement and that the tenant chooses to stay and pays rent to the lender, the non disturbance agreement creates a monthly tenancy continuing as long as the tenant pays rent. With an existing non disturbance agreement, the tenant paying rent to the lender is not subject to an annual tenancy. Nor is the tenant bound by the original terms of the lease either. These are real benefits to the tenant, allowing the tenant to stay or go as it deems fit.

However, a non disturbance agreement does not mean that the tenant has agreed to stay forever. There is always the option to leave. On the basis of the Goodyear case, the tenant can leave once the lender takes possession. So, the non disturbance agreement is one sided here. Opposite to this, an attornment agreement creates mutual obligations between lender and tenant. The tenant agrees to become the tenant of the lender and the lender agrees to become the landlord of the tenant, thus creating a tenancy stitching together both. It binds the lender to give the tenant possession and the tenant to pay rent.

Leasing Arrangement

Now arises the question, what is the leasing arrangement between the lender and the tenant in an attornment agreement?  Usually, the leasing arrangement is the same as the existing one between the landlord/borrower and the tenant. The issue is whether or not the lender has become the landlord under the original lease and is therefore bound by the equities between the landlord/borrower and the tenant, or there exists a new lease between the lender and the tenant but on the same terms as the original lease.

TDL Group Ltd v. 473807 Ontario Ltd.

The matter is taken up in the 473807 case, where the landlord is 1158631 Ontario Limited and the tenant is TDL Group Ltd., the franchisor of the brand name Tim Hortons. The landlord got a mortgage from 473807 Ontario Ltd., a family owned investor. The lender obtained an assignment of rents as collateral security and wished to be in a first position. TDL agreed to postpone its lease on condition that the lender entered into TDL’s standard Postponement and Non Disturbance Agreement, PNDA. The lender committed a big mistake by signing the PNDA without negotiation. Thereafter, the landlord, without legal right, locked out TDL from the leased premises, who obtained a court order to get back in and sued the landlord for damages. TDL succeeded in getting $62,000 as damages and $645,000 as costs, a total of $707,000. This amount was ordered to be set off against the rent under the lease, with the consequence that no rent would be payable under the lease for the balance of the 20 year term. The landlord defaulted under its mortgage with the lender, who took possession and attorned rents. TDL refused to pay stating that no rents were payable because of the set off. The lender maintained that it started with a clean slate and was neither bound by the set off, nor by the equities between the Landlord and TDL.

TDL contended that under the PNDA, the lender had become the landlord of TDL and was bound by the equities between the parties. The PNDA had created privity and the contract was the lease itself, a stance with which the Court of Appeal agreed, although the result was a catastrophic loss to the lender.

The Court of Appeal concurred with TDL for the following reasons:

1. The rights of the parties depended on the terms of the PNDA, the agreement between the lender and TDL;

2. The case is determined by contract interpretation;

3. The PNDA states that when the lender takes possession, it takes over the landlord’s position in the lease, thereby assuming the equities or state of accounts and, accordingly, was bound by the set off;

4. As it was a non disturbance agreement, TDL could not be disturbed from possession if it paid the rent under the lease. Due to the set off, there was no rent payable under the lease;

5. As it was also an attornment agreement and considering that the lender agreed to be the landlord, TDL agreed to attorn and become the tenant of the lender under the lease;

6. Though, under the lease, the lender became the landlord, that point was argued solely for the purpose of the rent set off;

7. The lender’s plea that the PNDA created a new lease between the lender and TDL on the same terms as the original lease was rejected because of the wording of the PNDA;

8. The court did not accept the Goodyear case as a precedent because there was no privity of contract in Goodyear. In this case, the PNDA created privity of contract;

9. The court rejected the law of assignment because the lender obtained an assignment of rents as collateral security, but not an assignment of the lease.

10. The court regarded the PNDA similar  to an assignment with respect to the equities between the Lender and TDL; and

11. In conclusion, on the equitable arguments, the court had this to say:

“Which of Two Innocent Parties Must Suffer?

74. My proposed disposition of this appeal undoubtedly seems harsh. The Mortgagee bears no responsibility for the wrongs done by the Landlord to TDL. It could not have anticipated that those wrongs would result in a judgment of over $700,000. Giving effect to TDL’s rights to set-off this judgment against rent may mean that the Mortgagee is deprived of rent for the entire balance of the Lease. Moreover, in this case, rather atypically, the tenant, not the Mortgagee, has the financial clout and leverage. The Mortgagee is not an institutional lender. TDL is the franchisor of Canada’s largest coffee chain. It is thus not hard to sympathize with the predicament of this entirely innocent Mortgagee.

75. But TDL is also an innocent party. It too could not have anticipated that the Landlord would act so irresponsibly. And, as Blenus Wright J. concluded, requiring TDL to pay rent before setting off its judgment would be unconscionable.

76. Thus, whatever the court’s disposition, one of two innocent parties will suffer. The PNDA says that the Mortgagee must suffer. The law of assignment says that absent an agreement to the contrary, the assignee must suffer. At least in this case the contract and the law correspond with the reality that the Mortgagee could have protected itself.

77. The Mortgagee must be taken to have known that the Landlord’s actions could potentially impair its ability to collect rent. The Mortgagee could have asked TDL for an estoppel certificate, which would have set out the state of accounts between TDL and the Landlord. It could have protected itself by a properly worded postponement and non-disturbance agreement. It could have asked TDL about the nature of the dispute with the Landlord. The Mortgagee did none of these things. Unfortunately for it, the Mortgagee must live with the consequences of its failure to do so.”

Lesson

The lesson from the verdict is that there is a distinction between non disturbance and attornment agreements. As the concepts are likely to be mixed up, it would be for the court to interpret the intention of the parties. Also, it is possible for the lender to be substituted for the landlord under an attornment agreement, the lender becomes subject to the equities. Lastly, the mortgagee should state categorically that it starts with a clean slate when it takes over.

Know your legal rights as a tenant or a landlord. For more information about renting in Toronto, and how you can use Ontario law to your advantage, contact the lawyers at Levy Zavet PC (Levy Zavet) in Toronto, Ontario.

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