Occupancy of Premises – Who is Liable for the Costs to Comply with Laws?

Partner, Robins Appleby LLP
  • May. 2, 2012

Darrell GoldThis article has been contributed by Darrell Gold LLB with Robins Appleby & Taub LLP

Where an offer to lease is silent on who has the onus to determine if the property complies with all laws (e.g. zoning bylaws, health and safety laws etc.), and whether the tenant’s use is permitted at the premises, then a March 2011 New Brunswick case, (Shunjing Trading Inc. v. E.B. Engineered Panels &. Controls Inc.) will be useful for guidance. Here are the case facts:

In 2005, the parties signed an offer to lease (“OTL”) for premises in a recently constructed strip mall for a two-year term. It provided that management fees and taxes were part of annual rent, but all other costs were additional rent for the tenant’s account. The OTL stated it was binding but was subject to signing a formal lease and tenant solicitor approval.

The tenant took possession without a formal lease. A few days later, it received a draft lease that made it responsible for “installation and/or improvement” costs required by governmental authority. This was not in the OTL. The tenant made inquiries and the fire department advised that occupancy was subject to installation of a fire alarm and sprinkler system costing about $10,000. The landlord told the tenant the cost was for the tenant as “additional rent” under the OTL. Lease negotiations ensued but no agreement was reached.

On July 27, 2005 the landlord gave the tenant 4 days to sign the lease. The tenant refused and vacated the premises on July 29. The landlord sued for the unpaid rent for the balance of the term.

At trial, it was revealed that the landlord had been told by its contractor previously that the premises would require a fire alarm and sprinkler system at a cost.

The tenant was successful at trial and was not liable for lost rent and “quitting” the lease. The landlord appealed and lost for the reasons below:

  1. Not a Binding OTL: at trial, it was held that the cost to rectify the fire code deficiencies was a material term not dealt with in the OTL. As a result the parties did not settle that material term and the OTL was not a binding contract.

  2. Capital Costs Are Not Additional Rent: the landlord argued that the compliance costs were “additional rent” under the OTL. The appeal court disagreed and said that additional rental expenses cover costs of a recurring nature, (e.g. water, hydro), and not a one-time cost for a capital improvement.

  3. Premises Unfit For Any Purpose: the landlord argued that common-law provides there is no implied warranty or covenant by a landlord that premises are fit for the purposes intended and the onus is on a tenant to ensure the premises are fit for the purpose intended, so there was no unsettled material issue as the tenant had to satisfy itself that the occupancy requirements were met. The Appeal Court disagreed since the premises were “literally unfit for any purpose” and the premises could not be “legally occupied until … municipal/provincial safety standards are met” and that is for the landlord to deal with..

  4. Matters of General Public Safety: The Court said that we should not reasonably expect that a tenant’s duty of due diligence includes determining whether the landlord or its contractor complied with governmental laws regulating construction of buildings “in regards to matters of general public safety”.

“In cases where the landlord has full knowledge and responsibility for regulatory requirements pertaining to safety matters for new construction, the law should not obligate tenants to make due diligence inquiries – or pay the installation costs for what amounts to a capital improvement – prior to entering into an agreement for lease”. To the extent the law places an obligation on the landlord to provide the tenant with physical possession on the commencement date “the landlord has the obligation to provide the tenant with the legal right to possession, regardless of who was responsible for applying for any occupancy permit.”

However, where the only impediment to the tenant’s legal occupation of the premises is an intended use which requires expenditures necessary to comply with the new support or provincial codes, the landlords argument that the tenant is responsible for the costs has merit. This latter exception did not apply to the facts of the case.

  5. Possession and Payment of Rent: the fact that the tenant took possession and paid the rent deposit normally results in a binding OTL under common law. However, here it was not sufficient since the parties continued to negotiate the issue without success and “It was simply a matter of time before the tenant’s occupation would’ve been declared unsafe and illegal and the issue of responsibility for the capital improvements would’ve been back on the table”.

  6. The Landlord’s Ultimatum: the landlord gave the tenant an ultimatum to sign the lease by a set date. In doing so the court said the tenant had the right to “quit” the premises. It was the landlord’s threat that gave the tenant an opportunity to walk away which the tenant took advantage of.

  7. The Landlord’s Knowledge: the landlord was fully aware of the need for the capital improvements for safety but waited until the formal lease was drafted to add a clause obligating the tenant to pay for them. According to the court, although currently “there is no generalized pre-contractual duty to bargain in good faith” this did not mean “that the law is going to turn a blind eye in cases where there has been non-disclosure of material facts”.

  8. Arguments Not Made: the court also noted that:

  a. The tenant did not argue the OTL was unenforceable at law for being “an agreement to agree” due to it being subject to signing a formal lease and the “reasonable approval” of tenant counsel.

  b. The landlord failed to argue that by taking possession and paying rent the tenant entered into a “periodic tenancy” irrespective of whether the OTL was binding. When a tenant takes possession and pays rent under a non-binding OTL, the tenant becomes a “periodic tenant from month-to-month or year-to-year, depending on the circumstances.”. As a two-year tenancy was intended by the parties, the periodic tenancy would be year-to-year and terminable at the end of one lease year on proper notice meaning the tenant would pay rent for one year with no termination until expiry of that year.

  c. The law is that where a landlord breaches a material lease obligation, the tenant does not have the right to then terminate the lease and walk away without liability as lease clauses are independent of each other not interdependent [as opposed to other contracts] i.e. a breach by one party in the lease does not entitle the other party to breach the lease (unless the lease provides otherwise).

Ultimately, the court said that it did not have to address these 3 arguments they were not raised by the parties. It seems however that the decision may have been different if one or more of them were advanced.

The Lessons: Based on the case (and subject to what your OTL says): 1. When a material cost (e.g. a capital cost) is within the landlord’s knowledge and it intends to have the tenant pay it, make sure the OTL addresses it; 2. The OTL must address all “”material” business terms – as a landlord its best to err on the side of caution and raise them in the OTL if you want the tenant to be liable. The lease stage is too late. 3. in matters of “general public safety” the onus and costs is on the landlord for compliance; 4. if the premises cannot be legally occupied for any use, the onus and cost is on the landlord for compliance; 5. the tenant must satisfy permitted use related compliance issues; 6. taking possession and paying rent can change a non-binding OTL into a binding one unless the parties continue to negotiate material terms in dispute; 7. Be wary of ultimatums – they can bring unexpected consequences; 8. non-disclosure of material facts can be detrimental even prior to a contract being signed; 9. the court will not make arguments to assist your case but they may refer to them and suggest that a different outcome might occur if only counsel had raised them.

Disclaimer: This article is for general information purposes only and not intended as or to be relied upon for legal advice. Consult with a lawyer for your unique situation.

[*If there is a general real estate or leasing related question you would like to see addressed in a future article in “The Legal Corner”, please contact me directly by e-mail at [email protected] with your suggestion. Not all requests can be accommodated.]

Darrell Gold is a partner at Robins Appleby LLP and is responsible for the leasing component of its Real Estate Group. He has extensive experience and expertise in all aspects…

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Darrell Gold is a partner at Robins Appleby LLP and is responsible for the leasing component of its Real Estate Group. He has extensive experience and expertise in all aspects…

Read more

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