February 24, 2017

Re-litigating Rent Renewal Clauses: No Encores Please

Re-litigating a rent renewal clause in a long-term commercial lease is often unavoidable. After adjudication of the interpretation of a rent renewal clause, circumstances may change before the next renewal. The parties may then adopt conflicting interpretations, resulting in wildly divergent rent valuations. In these cases, litigation may be the only option when the alternative is a lopsided arrangement that is no longer commercially viable for one of the parties. However, absent a significant or "special" change in circumstances, a party will not be permitted to re-litigate the clause simply because the rent is up for renewal.

The importance of a rent renewal clause in a long-term lease cannot be overstated. The amortization of major leasehold developments can take up to forty years before a lessee/developer recoups its investment. Many leases provide for a rent reset before the amortization period ends, often every ten or twenty years. The objective of the reset is to ensure that the rent remains consistent with property and money values. To this end, a rent reset clause is intended to add certainty to the lease so that the lessor and lessee are assured that the arrangement will remain economical for its duration.

Even clearly worded rent renewal clauses can result in disagreement at renewal time. Consider a formula that sets the rent at a percentage of the fair market value of the leased land. Courts have described this formula as one by which a conservative investor seeks a modest return with maximum certainty and minimum risk. Even this plainly worded formula has been susceptible to litigation and re-litigation in a variety of contexts. It was recently at issue before the Court of Appeal for Ontario in Victoria University (Board of Regents) v. GE Canada Real Estate Equity, [2016] O.J. No. 4493.

In Victoria University, the rent in question was to be reset at 6 per cent of the fair market value of the demised lands. At issue was whether the "fair market value of the demised lands" meant a valuation of the "lands" based on an unencumbered freehold interest or leasehold interest. The parties were subject to a one hundred year lease. Since the outset of the lease, there had been two rent renewals. At each renewal, the interpretation of the rent clause was arbitrated and then appealed.

After the first arbitration, the Divisional Court set aside the arbitral award and held that the lands were to be valued as if vacant but encumbered by a lease. To disregard the lease would ignore the reality that the tenant could not develop condominiums on the property because of restrictions in the Condominium Act in force at that time. At the second renewal arbitration, the majority of the arbitrators held that only the freehold interest in the land was to be valued without consideration of the lease. An appeal to the Superior Court of Justice was allowed and the Court of Appeal in Victoria University affirmed Justice Herman Wilton-Siegel’s conclusion that the lands should be valued as freehold but encumbered by a lease, consistent with the adjudication of the first renewal.

The Court of Appeal rejected the argument that changes to the case law and legislation warranted a reconsideration of the rent renewal clause. There had been no change in the law that gave rise to special circumstances that justified withholding the application of the issue estoppel doctrine. The Court of Appeal stated that "While it is true that the rent was to be reset every twenty or thirty years, the interpretation of the leases should as a matter of principle be caught by issue estoppel and an encore should be prevented. … Just because the rent payable under the Leases will be reset again in the future does not mean that litigation on the same issue between the same parties should be permitted." 

All hope is not lost for a party stuck with a money-losing interpretation of a long-term lease. The adjudicator must be persuaded that there has been a change since the previous determination that gives rise to special circumstances warranting a reconsideration of the renewal clause. It remains to be seen whether dramatic market changes that render a lease unaffordable for a party will qualify as "special circumstances". Courts have generally preferred to hold the parties to the strict language of the lease regardless of the financial consequences that manifest.  

It should go without saying that parties enter into a long-term lease with the expectation that the lease will be profitable. In this post-Sattva era, evidence of the factual matrix of the lease may inform the parameters of this point. In Victoria University, the court looked to the factual matrix but found little evidence of it. Whether this type of evidence would have influenced the result the second time around is unknown, at least until the next renewal perhaps.