What happens when a commercial tenant has the option to purchase the property it is leasing, but the parties cannot agree on the value? The simple answer is to do what the lease says.  

If they don’t, it can result in the loss of a very valuable asset.

In an interesting dispute, the Ontario Court of Appeal was asked to settle a contentious disagreement over the purchase of two commercial properties in Whitby.  The properties were leased by the Tenant, a car dealership operator, from the Kandlord, which owned and previously operated the dealerships for 18 years. 

The properties were part of a 2015 deal where the Tenant bought the car dealerships for approximately $30 million, with leases allowing continued operation on the properties. Importantly, these leases included an option for the Tenant to purchase the properties, with the purchase price to be set by averaging two appraisals — one chosen by each party.

The facts of the case

In 2020, the Tenant, after failing to renew the leases in time, opted to exercise its purchase rights as its only option to stay on the properties. This move initiated a series of events that led to disagreement and eventual litigation.

The Landlord’s appraisal, done by Colliers International Group Inc., valued the properties at $31,200,000 based on an assumption that the highest-and-best use of the land would include rezoning for residential development. The Tenant’s appraisal, conducted by Equitable Value Inc., assessed the properties at $11,746,000 based on current zoning and commercial use.

The stark difference between these appraisals resulted in a midpoint of $21,473,000.

The parties disagreed on the validity and fairness of each other’s appraisals, with accusations that each side’s valuation was tailored to serve their interests: the Landlord’s to maximize sale proceeds, and the Tenant’s to minimize the purchase cost. The Landlord subsequently obtained additional appraisals that placed the value between $24,500,000 and $27,480,000, further supporting its higher valuation.

Despite ongoing disputes, the Landlord indicated readiness to close the deal at the midpoint price of $21,473,000. However, the Tenant refused, arguing the Landlord’s appraisal was speculative and invalid. The Tenant attempted to close by tendering only $11,746,000 — the value from its own appraisal — while unilaterally holding the balance of $9,727,000 in trust with its lawyer, pending resolution of the appraisal dispute.

The Landlord rejected this approach, stating the tender was non-compliant as it did not match the agreed midpoint price, and returned the funds.

The court's ruling, and the appeal

The Tenant then sued to enforce the sale at its tendered amount, or at alternative prices it calculated based on its interpretation of fair value. The Landlord countered with a request to declare the options void and remove any registration related to the purchase from the land title, while also seeking vacant possession.

The lower court judge initially ruled in favor of the Tenant, finding both appraisals were compliant with applicable standards and the Tenant’s partial tender was valid given the dispute over the purchase price. The judge ordered specific performance, setting the price at the midpoint of $21,473,000.

However, on appeal, the decision was reversed.

In doing so, the court emphasized the strict nature of option contracts. Once exercised, an option creates a binding purchase and sale agreement, requiring adherence to its terms.

The court found the Tenant breached the contract by failing to tender the full amount of the purchase price. The Tenant’s approach of tendering part of the payment and holding the rest in trust was deemed insufficient and unilateral, leaving the Landlord justified in refusing to convey the title.

The court rightfully stated that, if the Tenant was permitted to proceed that way “it would mean that vendors would be required to convey property in any circumstance where, as here, the purchaser disputes the purchase price, potentially resulting in a substantial part of the proceeds of sale being held up indefinitely, pending years of litigation.”

It was also pointed out “the Landlord did not agree to the funds being held in trust, and the funds were not even placed in trust irrevocably, but were later returned to the Tenant, which used them to purchase other car dealerships.”

Given that the appeal court sided with the Landlord, the Tenant also tried to argue that, despite breaching the agreement, it should not lose its right to purchase the properties. The court disagreed and noted the parties were both sophisticated and “engaged in elaborate, protracted, and hardnosed negotiation.”  

It was also noted the Tenant could have protected itself by tendering the purchase price and then suing afterward for the disputed appraisal. Instead, the Tenant “engaged in a strategy to enable it to acquire the properties at substantially below fair market value. The strategy failed. There is no reason that it should be relieved of the consequences.”

Ultimately, the appeal court declared the purchase options null and void, ordered their removal from the land registry, and awarded costs to the Landlord. 

The moral of the story, and a parting thought

The short moral of the story is that, given the nature of the lease clause, both sides produced valid appraisals and they were required to buy and sell the property at the midway point.  If a buyer fails to honour that agreement, it will lose the right to purchase.

However, this scenario also raises questions about what could potentially happen in this situation.  As in, what if one side gets an appraisal and is unreasonably high or low and could not be any sort of fair representation of the value of the property.  If that were to happen, it would not be reasonable for the other side to meet them halfway.  

The better strategy may be that, when negotiating an option-to-purchase clause, it may be best to require both sides to obtain a single, third-party appraisal of the property and agree to buy and sell at the appraised value, rather than require them to meet halfway.