ARE RESTRICTIVE COVENANTS (NON-COMPETITION CLAUSES) BETWEEN NEIGHBOURING PROPERTIES LEGALLY ENFORCEABLE?

Two neighbouring property owners  (Provigo & El-Ad) are bound by a contract which provides that El-Ad will not allow the sale of food on its shopping center premises for as long as Provigo operates a food supermarket on its neighbouring property.

The Quebec Superior Court decided that the contract was not legally enforceable for the following reasons (Complexe Commercial De L'Île Inc. v. Provigo Distribution Inc. et al., 2018 QCCS 5284).

The validity of such restrictive covenants is determined by well settled principles established over time by case law:

1.     Undertakings in restraint of trade are generally against public order;

2.     There may, within reasonable limits, be contractual restrictions on freedom to conduct a specified commercial activity;

3.     The validity of such restrictions is dependent on their being reasonable, particularly with respect to the activity that is sought to restrict, the duration of the restriction, and the applicable territory;

4.     The restrictions must be necessary for the reasonable protection of the legitimate interests of the party in whose favour they are granted.

Relevant Facts:

For many years, Provigo was a tenant in the shopping center owned by El-Ad's predecessor. A clause in the lease granted Provigo exclusivity in the shopping center  for the operation of a food supermarket.

In 1993, Provigo purchased a vacant property across the road from the shopping center from El-Ad's predecessor. 

In 2004, Provigo sold part of the vacant property to El Ad and kept the remainder for itself in order to build a food supermarket. 

El Ad agreed not to operate a food supermarket in the shopping center or on the purchased land.

El-Ad and Provigo agreed to require from any future purchaser of their properties a written undertaking to respect the restrictive covenant.

The parties agreed to register real and personal servitudes  (easements) on their properties to reflect their undertakings.

Provigo built a supermarket on the retained land. 

El-Ad sold the shopping center to CCI who expressly agreed to be bound by the restrictive covenant. Nevertheless, CCI argues that the restrictive covenant is null and is not legally enforceable.

The Court recognized that the public interest lies in freedom of commerce and not in the restriction of commercial activities. Consequently, the legal burden will rest with the party seeking to enforce a restrictive covenant to show that the restriction is limited to what is necessary to protect its legitimate commercial interest.

In the present case, the restrictive covenant had no fixed term and continued at Provigo's sole discretion. The Court concluded therefore that the restrictive covenant was subject to an indeterminate term which could be perpetual, thereby offending public order.

A contractual undertaking that offends public order is not legally enforceable, notwithstanding that CCI expressly undertook to be bound by it. There are legal limits to what one may freely consent to in a contract.

Although the parties registered real and personal servitudes on the property, this had no legal effect since it is recognized that non-competition clauses cannot be registered as servitudes. A prohibition to carry on a certain type of activity does not benefit the dominant property, which is a fundamental precept of a servitude. Rather than benefitting the dominant property, the prohibition confers an advantage on the owner of the dominant property for as long as he operates the activity that benefits from restricted competition. Should the activity change, such as by the owner moving the activity to a different property, the prohibition would be without purpose or meaning.

Finally, the Court distinguished the restrictive covenant in an agreement between two property owners from an exclusivity clause often found in commercial leases. The primordial difference is that a commercial lease has a fixed term or if the term is indeterminate, either party could cancel upon giving reasonable notice. An exclusivity clause in a lease cannot be for a perpetual duration and consequently, will not offend the basic principles referred to above.

THE FLIP ARGUMENT

A commercial lease may include an option to purchase the building in favour of a tenant. Such clauses are generally personal to the tenant and non-transferable or assignable. When the option specifies a sales price, what is to prevent the tenant from purchasing the property and flipping it to a third party (who may be a competitor of the owner) for a profit? Would this contravene the option clause? The contestation of the exercise of the option clause is sometimes referred to as the flip argument, which was considered by the Quebec Court of Appeal (4207602 Canada Inc. -v- 9139-4882 Quebec Inc.et al., 2018 QCCA 1035).

The option clause in the lease reads as follows:

11. OPTION TO PURCHASE

Provided the LESSEE [(Cameo)] is not in default at any time, either before or after the exercise of the present Option, the LESSEE is hereby granted options to purchase the Leased Premises at the following prices, in all cases without any warranty whatsoever, legal or otherwise, to be exercised by written notice to be given on or prior to the following respective dates:

[…] 

The Leased Premises shall be sold to the LESSEE free and clear of all hypothecs. […] The LESSEE hereby acknowledges that it has been in occupation of the Leased Premises since 1992 and, consequently, has full and complete knowledge of the state and condition of the Leased Premises and of all matters or issues pertaining to such state and condition and hereby expressly represents to be fully satisfied therewith, except as herein expressly provided under the terms of clause 46 hereof.

This Option to Purchase is a personal right of the LESSEE and is neither transferable nor assignable, unless made to a related party, and shall be valid only provided LESSEE is not in default of any other term or condition of the Lease.

The trial judge rejected the claim of the tenant for transfer of title by maintaining the flip argument. More particularly, she found that the evidence showed that the tenant's intention was not to acquire the property for its own use and benefit but rather to flip for a profit which she found contravened the option clause. She consequently dismissed the claim of the tenant.

The Court of Appeal did not agree with the trial judge's reasoning and rejected the flip argument but maintained the conclusions of the judgment on other grounds.

The Court of Appeal cited Article 1212 of the Quebec Civil Code which provides that "A restriction on the exercise of the right to dispose of property may only be stipulated by gift or will". According to the terms of the Option, the tenant could not transfer or assign it to a third party, but it could nevertheless exercise the Option and do as it wished with the property once it became the owner. 

The landlord refused to transfer title to the tenant in February 2007 and the latter filed suit in November of the same year claiming damages calculated on the basis of the lost gain that would have resulted from the re-sale of the property. It was not until April 2011, almost 4 years later, that the tenant amended the court proceedings to request a judgment granting it title to the property. 

Contrary to the trial judge, the Court of Appeal found this delay to be unreasonable and a bar to the tenant's claim for transfer of title. Such a claim must be exercised within a "reasonable delay" from when the claim arose otherwise, it could give rise to great uncertainty. For example, the owner of the property would presumably have repairs or renovations to undertake and grant hypothecs on the property to secure financing, all of which would be put in risk during a lengthy period of title uncertainty.

The other issue upon which the Court of Appeal and the trial judge diverged concerned one of the essential conditions for a successful transfer of title claim: evidence that the claimant has the financial resources at all relevant times to pay the purchase price. Until the Court of Appeal decision of Houlachi v. Bray, 1997 CanLII 7108, the claimant was obligated to tender the full amount of the purchase price into court. This rule effectively limited the legal recourse to those who could pay the full price in cash. Since Houlachi,the rule was significantly tempered to require evidence that the claimant had the financial resources necessary to complete the transaction, such as a commitment from a financial institution to lend the funds. According to the Court of Appeal, such evidence was lacking and the claim for transfer of title had to fail on this ground as well.

BAD FAITH VENDOR CAN BE HELD RESPONSIBLE FOR AN APPARENT DEFECT *

Article 1726 of the Quebec Civil Code states that the seller is bound to warrant the buyer that the property and its accessories are free from hidden defects that render it unfit for the use for which it was intended or which so diminish its usefulness that the buyer would not have bought it or paid so high a price had he been aware.

The case law requires that a buyer act prudently in order to invoke the warranty of quality. He is generally required to have the property inspected by a qualified professional. In the face of any indicators that a defect may exist, the prospective buyer should take reasonable steps to investigate further, which may include obtaining the opinion of an expert. When such indicators are present and the buyer omits or neglects to follow up with amore in depth investigation, the defects which it is presumed he could have become aware of if not for his imprudence will generally be regarded as apparent and therefore not covered by the seller's warranty of quality.

However, certain circumstances such as false or misleading representations by the seller could falsely reassure or confuse a buyer regarding the nature or existence of indicators that should normally be investigated further. False or misleading reassurances by the seller tending to provide innocent explanations to explain the presence of such indicators designed to steer a buyer in a different direction could serve to exculpate an otherwise negligent buyer. 

The parties to a contract have a legal duty to act in good faith. Where a buyer is less than prudent by omitting or neglecting to investigate further, clues of which he is or should be aware that a defect could exist, the seller could still be held liable if he knew of the existence of a defect that he failed to disclose or withheld material information about the possible existence of a defect from the buyer. For example, a seller who has in his possession, a copy of a revealing pre-inspection report commissioned by another prospective purchaser tells a buyer that such a report does not exist or is not available. If the report contains material information about the actual or possible existence of a defect, the seller's liability could be engaged even when the defect might otherwise be considered as apparent if the withholding of such material information contributed to the buyer being misled.

Apart from a recourse based on the warranty of quality, it could also be argued that a seller who has made false or misleading representations to a buyer could be found liable for having breached his duty to act in good faith.

*For an illustration, see Leclerc et al. -v- Lemieux et al.,2019 QCCS 1209

OPTION TO PURCHASE CLAUSE IN COMMERCIAL LEASE

It is well known that a tenant of a commercial lease can register the lease at the land registry office to make it enforceable against a subsequent acquirer of the property. For example, if a lease is not registered, a developer who acquires the property can cancel the lease after 12 months by giving at least 6 months prior notice, even if the lease is for a much longer term. If the lease is registered, the subsequent acquirer must respect it.

However, an interesting legal issue arises when the lease contains an option to purchase clause in favour of the tenant. Does registration of the lease make the option to purchase enforceable against third persons together with the other terms of the lease? This issue was the object of a judgment rendered by the Superior Court on 2018-02-16. (Procureur Général du Canada -vs- 555 Carrière Inc. et al., 2018 QCCS 565)

Summary of the Facts

The property includes an office building that was built in 1983 and 1985 consisting of 6 stories for offices. Bourque, the original owner, entered into a lease with the Government of Canada ("GOC") for a term commencing 1985-06-01. The parties renewed the lease for a 25year term commencing 1991-09-30 and terminating on 2016-07-31. The lease included an option to purchase for $15 million and was registered at the land registry office.

On 1991-10-01, Bourque hypothec's the property in favour of TBN who registered a prior ("60 day") notice on 2002-01-10. After the expiry of the 60day legal delay, TBN instituted foreclosure proceedings to take the property in payment of its claim. GOC did not intervene in the case.

On 2007-11-26 TBN assigns and transfers its rights to the hypothecary claim to Computershare.

On 2009-12-21 the Court renders a judgment pursuant to the consent of the parties which granted the taking in payment suit and declared Computershare owner of the property retroactive to 2002-01-10. There was no appeal from the judgment, which was registered at the land registry office on 2010-01-25.

On 2010-04-06 GOC informs Computershare that it intends to exercise the option to purchase at the end of the lease. On 2010-04-15 Computershare replies through its attorneys that the option to purchase is not legally binding upon it.

On 2010-08-18, Computershare sells the property to Gestion 555 for $43,974,908.01 who charges the property with 3 hypothecs.

On 2011-08-04, Gestion 555 formally notifies GOC that it recognizes the validity of the lease but that it is not bound by the option to purchase.

GOC filed suit to declare the option to purchase valid and binding against Gestion 555. After the expiry of the lease, it also asked the Court to be declared the rightful owner of the property.

Reasoning of the Court

It is well established that rights resulting from a lease are personal i.e. not real rights which are rights in property. An option to purchase is a personal right that can be enforced against the person who granted it but does not confer any right in or to property itself. As such, a personal right such as an option to purchase or promise to sell is generally not subject to registration and therefore not enforceable against third parties who have not voluntarily assumed the obligation.

In the opinion of the Court, the lease and the unilateral promise to sell (i.e. the option to purchase) are two distinct contracts that are governed by their respective rules even if they co-exist in the same document. Personal rights, as opposed to property rights, can be enforced against the parties to the contract but not against third persons. The law creates an exception for leases by allowing them to be registered but according to the Court, this is an exception to the general rule and should be interpreted restrictively.  The Court went as far to say that it would make no difference to her interpretation of the law if the inclusion of the option to purchase was a fundamental consideration for the GOC to enter into the lease. According to the Court, the protection afforded by registration of the lease is limited to the essential terms and conditions of a lease namely, the description of the property, the amount of rent and the duration. 

An option to purchase is not a right resulting from a lease and therefore cannot be registered. The Court suggested that if GOC wished to protect its right, it could have done so by requiring a hypothec to be registered on the property to guarantee performance of the option to purchase.

The result could have been different for GOC had there been no taking in payment judgment. When a property is sold, the buyer generally assumes all of the seller's obligations pursuant to existing leases, which would have made the option to purchase enforceable against the new owner. Computershare's title based on the judgment contained no such obligation.

CONDO SYNDICATE'S LIABILITY FOR DAMAGES CAUSED BY FAULTY DESIGN, CONSTRUCTION DEFECT AND LACK OF MAINTENANCE IN COMMON PORTIONS

The recent court decision in Robitaille v. Syndicat de la Copropriété les Condos du Marché Jean-Talon et al., 2018 QCCQ 7531 provides a useful illustration of the analysis of the problem and the determination of responsibility amongst the different actors.

Robitaille ("R") claims from the condo Syndicate $29,484.03 representing damages that she claims to have incurred as a result of noise and abnormal vibrations from the building's ventilation and air conditioning system ("HVAC"). The Syndicate in turn claims from Pham, the owner of one of the commercial condos in the building where she operates a restaurant, to be held harmless from R's claim in so far that the Court determines that the cause of the problem is the lack of maintenance of the HVAC of which Pham has the exclusive use.

The facts can be summarized as follows:

2014-05-14: R purchases the condo which was built in 2005. The building includes 7 residential condos including that of R, which is situated on the highest level just below the roof.

The HVAC is installed on the roof. It comprises an evacuation ventilator connected to the stove of Pham's restaurant and 4 compressors.

2014-06: R hears a loud noise appearing to come from the ventilation system. She hears the noise and feels the vibrations in her bedroom.

2014-07: R complains the Syndicate board.

2014-07-16: Syndicate installs pads under the HVAC to temper the noise and vibrations.

2014-08-14: The noise and vibrations persist. R sends a default notice to the Syndicate calling upon it to retain the services of an expert to analyse the problem and propose corrective measures.

2014-07 to 2015-12, the Syndicate hired different experts and followed several of their recommendations. Notably in 2015-11, it installed soundproofing on the HVAC and at R's bedroom at a cost of about $25,000.

2016-03-29: R sends Syndicate a new default notice calling upon it to correct the problem relating to impact type noise emanating from the HVAC.

2016-05-05: With the Syndicate's authorisation, R installs a rheostat on the HVAC at a cost of $4,484.03 at her own expense. As a result, the noise and vibration problem is acknowledged by R to be resolved to her satisfaction.

2016-06-09: R claims from Syndicate, $18,984.03 comprising the cost of the rheostat, trouble and inconvenience and her legal fees.

2016-07: R settles with her vendor for $11,500 representing compensation for damages relating to the HVAC defects that she complained of and releases him from all such claims.

R argued that the Syndicate was negligent in omitting to install a rheostat as recommended by the experts and by its tardiness in implementing other recommendations of the experts. The Syndicate argued that it acted prudently at all times and incurred $40,000 in costs to rectify the problem. According to the Syndicate, the problem was rectified in 2015-11 and no further corrective work was required thereafter.

According to Article 1077 of the Quebec Civil Code, the condo Syndicate is liable for damage caused to co-owners or third parties by faulty design, construction defects or lack of maintenance of common portions. The liability of the Syndicate includes common portions of which one or more co-owners have the exclusive use, use such as the HVAC in this case. If the damage is the result of lack of maintenance or repair, then the Syndicate could in turn claim against the co-owner(s) having such exclusive use, to be indemnified against condemnations in favour of other co-owners or third parties.

To establish the liability of the Syndicate for lack of maintenance or repair, the latter must have committed a fault i.e. to have acted imprudently in relation to its obligation to maintain and repair. The Syndicate is not held to a standard of perfection but rather that of acting prudently. R has the burden to prove the existence of a fault on the balance of probabilities.

The Court concluded that, based on the evidence, R did not succeed to prove the existence of any fault attributable to the Syndicate regarding maintenance or repair. It hired several experts to try to resolve the problem. It was diligent and cooperated with R to find a solution.

The liability of the Syndicate for faulty design or a construction defect is established even in the absence of any fault. One must prove the existence of the faulty design or construction defect in a common portion and that it caused damage.

According to the Court, the existence of a construction vice or faulty design of the HVAC existed between 2014-06 to 2015-11. The various expert reports established that the noise and vibrations generated by the HVAC constituted a defect. The evidence also established that the expert Lefebvre in 2015-12 and Duée in 2016-05 both recommended that a rheostat be installed on the HVAC, which the Syndicate refused to do. 

Since a defect existed in the common area which the Syndicate had the legal obligation to correct with the installation of a rheostat as recommended by the experts, the Syndicate is liable pursuant to Article 1077 CCQ.

The Syndicate also argued that it benefited from the release that R granted to her vendor in so far as the compensation that she received was for the costs of the rheostat and moral damages, the same claims that R asserted against the Syndicate. Should R be compensated twice for the same damages by "double dipping"?

Normally, when two debtors are jointly and severally held together to pay the same debt, the payment of the entire debt releases both debtors. However, the vendor and the Syndicate cannot be joint and several debtors because the source of their obligations are different: the vendor pursuant to the sales agreement and the Syndicate pursuant to a statutory duty (i.e. Article 1077 CCQ).  In such cases which occur frequently, the theory of in solidumdebtors applies with similar consequences for the creditor. When one in solidumdebtor pays the entire debt, it releases the other in solidumdebtor.

In the present case, the Court concluded that R's claims against the vendor and the Syndicate were substantially the same so that the release of the vendor was a bar to asserting the same claim against the Syndicate. Although the Syndicate was legally responsible for the damages caused by the defect in the common portion, R's claim against it must fail because she had already received her just due from the vendor.

But what of the warranty claim of the Syndicate against Pham? It had two purposes: to indemnify the Syndicate for any condemnation that it received at the hands of R which in the circumstances, is without object.

The second purpose was to obtain reimbursement for the costs of expert reports and for the corrective work undertaken by the Syndicate to the HVAC. The Court considered that this claim was well-founded in virtue of Articles 1064 and 1077 CCQ and Article 22 of the Declaration of Co-ownership.

Article 22 provides that the expenses relating to the use of restricted use common areas are to be borne by the beneficiary(ies) of such use. Furthermore, such restricted users could be obliged to pay a special assessment to the contingency fund to cover major repairs and replacement of such restricted use common portions.

The Court's decision to maintain the warranty claim appears to be wrong. The liability of a co-owner such as Pham is limited to costs resulting from lack of maintenance or repair to a common portion of restricted use, not corrective work resulting from faulty design or a construction defect, which is what the Court concluded to be the source of the excessive noise and vibration. 

The Syndicate may, when establishing the contribution to the contingency fund, take into account the rights of one or more co-owners having exclusive use of common portions and assess such co-owner a larger amount than the relative value of his fraction and the contributions of the other co-owners would be reduced accordingly (Article 1072 CCQ). However, in my view, this should be done as part of the Syndicate budgeting process and would not otherwise give the Syndicate the automatic right to assert such a claim as it did in the present case.