CAN A LANDLORD CLAIM ARREARS OF RENT FROM A FORMER TENANT IF THE PREMISES ARE SUBSEQUENTLY LEASED TO A NEW TENANT FOR A HIGHER RENT?

The Court of Appeal addressed this and other interesting issues in Groupe Van Houtte Inc. vs. Les Développements Industriels et Commerciaux de Montréal Inc., 2010 QCCA 1970.

Van Houtte and the Landlord entered into a commercial lease for the period commencing March 15, 1988 and ending March 14, 1998. In December 1996, Van Houtte’s franchisee abandoned the leased premises and left them in an extremely poor condition, which Van Houtte exacerbated by removing equipment, furniture and signs.

Subsequently, Van Houtte and the Landlord negotiated and entered into a Lease Extension Agreement for an additional period of ten (10) years until March 14, 2007. However, Van Houtte stopped paying the rent on March 19, 1998. In November 1998, the Landlord entered into a lease for the premises with a new tenant with retroactive effect of one month. The new lease provided for a substantially higher rent which the new tenant paid for a period of ten years until October 31, 2008.

According to Van Houtte, the total revenue collected by the Landlord under the new lease was greater than what it would have collected under the Lease Extension Agreement, including all unpaid arrears of rent. Van Houtte argued that consequently, the Landlord in fact incurred no loss by Van Houtte’s default and therefore was not legally entitled to collect any unpaid rent that accrued before the new tenant moved in. Van Houtte asserted that the non-payment of rent was the result of its breach of contract which gave rise to a potential claim for damages. Since no damages could be proven by the Landlord, who was actually better off as a result of Van Houtte’s default, the latter argued that the Landlord’s claim was without legal merit.

Unfortunately for Van Houtte, both the Landlord and the Quebec Court of Appeal saw the situation differently.

The Court of Appeal decided that the claim of the Landlord for unpaid rent could not properly be qualified as “damages” i.e. the dollar value of what it would take to indemnify the Landlord for its loss resulting from Van Houtte’s breach of contract. Instead, the Court considered that the legal basis of the Landlord’s claim was the specific performance of the tenant’s obligation to pay rent under the Lease Extension Agreement. The previous tenant is responsible to pay the rent until the new tenant takes over. Although the Landlord made a profitable deal with the new tenant for a higher rent, the resulting financial benefit belongs to the Landlord alone and has no legal impact on the obligation to pay rent by Van Houtte for the period prior to the date when the new tenant moved in.

The Landlord also wanted Van Houtte to pay the rent for the first three months of the new lease which the new tenant was granted for free as a lease incentive. The Court of Appeal refused this claim, reasoning that since Van Houtte’s responsibility was limited to the rent payable under the former lease, the latter cannot be held responsible for rent payable subsequent to the end of the previous lease which coincided with the occupancy of the new tenant. Furthermore, the Court of Appeal considered that based upon the evidence, the three months of free rent that the Landlord granted to the new tenant was not proven to be damages incurred by the Landlord resulting from Van Houtte’s breach of contract but presumably, part of the ordinary cost of doing business. The Court appeared to have left the door open to the situation where it is proven that the free rent is the direct result of the lamentable condition of the premises left by the defaulting tenant.

The Landlord also claimed reimbursement of the legal fees and expenses that it incurred to enforce the terms of the lease. Based on previous case law, this clause would have been unenforceable as being too vague since arguably, the Landlord and his lawyer could unilaterally determine the amount payable by the defaulting tenant.

In the circumstances, Landlords were usually advised to draft the clause so that a percentage of the amount in default, usually between 15% and 25% would be recoverable from a tenant in default, which appeared to satisfy the Courts by removing the discretionary element from the calculation. The Court of Appeal, however, has modified the law on this subject by concluding that even without a specific percentage, such clauses may nevertheless be enforced. The burden is on the plaintiff, i.e. the landlord, to prove that the collection costs are just and reasonable, which in any event, is an ethical obligation imposed on all attorneys in Quebec with respect to the legal fees that they charge. In the circumstances, since the Courts are in a position to supervise and control such claims and intervene to revise exaggerated or abusive claims, such clauses are now considered to be legally valid and enforceable.

The impact of this evolution in the law is significant since it enhances the accessibility to justice of a claimant by improving the economics of the process. If a landlord could not add the collection costs to a claim, every exercise in debt recovery would automatically be an economically losing proposition.