SHOULD LENDERS BE CONCERNED ABOUT STATUTORY DEEMED TRUSTS?

A statutory deemed trust is an unregistered floating charge on the property of a fiscal debtor who is in default to remit deductions at source to fiscal agencies. It takes precedence over any other security interest such as a mortgage or hypothec.

For example, a lender secures a loan on a building with a first-ranking mortgage. The borrower subsequently defaults to remit deductions at source. The fiscal agencies, both Canada Revenue Agency and Revenu Québec, will get paid before the lender.

An interesting illustration of how a bank arguably mismanaged a statutory deemed trust can be found in Banque Nationale du Canada v. Agence du Revenu du Québec et al., 2011 QCCA 1943.

The facts can be summarized as follows:

In May 1994, the Bank lends Canouxa (the “Borrower”) the sum of $175,000.00 secured by a first-ranking movable hypothec on property of the Borrower (the “Secured Property”). Furthermore, the loan is guaranteed by Egido (the (“Guarantor”) who takes a second-ranking movable hypothec on the Secured Property.

Between May 1995 and December 1999, the Borrower is in default to remit deductions at source to Revenu Québec.

On November 2, 1999, the Borrower is put into bankruptcy. The Bank is a secured creditor for the amount of $41,725.75 in virtue of its first ranking hypothec.

On February 10, 2000, the Bank serves on the bankruptcy trustee and registers a prior notice which is followed by a motion to foreclose i.e. take in payment the Secured Property.

On June 6, 2000, a consent judgment is rendered declaring the Bank to be the owner of the Secured Property and in consideration for the payment of the sum of $47,295.75, the rights resulting from the Judgment are assigned to the Guarantor.

In May 2001, Revenu Québec claims the Secured Property from the bankruptcy trustee to the extent of $21,560.73 on the basis of a statutory deemed trust as recognized by Sub-Section 67(3) of the Bankruptcy and Insolvency Act.

In June 2001, Revenu Québec learns that the Secured Property is no longer in the possession of the bankruptcy trustee and thereupon demands payment from the Bank in the amount of $21,560.73 based on the alleged statutory deemed trust.

The Bank argued that the funds it received from the Guarantor were not proceeds from the sale of the Secured Property that would be subject to a statutory deemed trust but instead, consideration for the assignment of the loan, adding further that Revenu Québec should have pursued the Guarantor who acquired the Secured Property, not the Bank.

Both the trial judge and the Court of Appeal rejected the Bank’s argument on the basis of their interpretation of the consent judgment that intervened between the Bank, the Borrower and the Guarantor, and concluded that what the Bank transferred to the Guarantor was not a hypothecary loan but rather title to the Secured Property itself.

The Court of Appeal made an interesting distinction between the statutory deemed trusts of the Canada Revenue Agency and Revenu Québec which are created by different statutes and are worded differently. The Federal statute (paragraphs 227(4) or (4.1) Income Tax Act) deems all property of the fiscal debtor to be subject to the statutory deemed trust. In contrast, Article 20 of the Quebec Tax Administration Act appears to limit the scope of the statutory deemed trust to the funds that the fiscal debtor should have remitted and does not necessarily attach to any other property of the fiscal debtor. In the case at bar, the Bank did not raise this argument and may have therefore implicitly acquiesced that the scope of Revenu Québec’s statutory deemed trust was as large as that of the CRA.

The Court of Appeal added that Revenu Québec had the evidentiary burden to establish that the fair market value of the Secured Property sold by the Bank to the Guarantor was at least equal to the amount of its claim. Revenu Québec did not offer such evidence but instead, submitted that the fair market value of the Secured Property was equivalent to the amount paid by the Guarantor.

In the circumstances, the claim of Revenu Québec should have been dismissed on the basis of lack of evidence. However, Revenu Québec was saved by the fact that the Bank had filed a certified evaluation of the Secured Property which established the value between $36,000.00 and $45,000.00.

In light of the foregoing, a lender should be prudent when evaluating the security given for a loan since subsequent events, i.e. the default of the borrower to remit deductions at source to the fiscal agencies, may significantly depreciate the value of the security. Aside from requiring additional guarantees or a greater contribution of equity from the borrower, the lender could require the borrower, as a condition of the loan, to provide periodic statements from the fiscal agencies to confirm that the borrower is in conformity with its statutory filing and remittance obligations.

BINDING PROMISE TO CONTRACT OR NON-BINDING BASIS FOR NEGOTIATIONS?

A Quebec Court of Appeal decision, Europe Cosmétiques Inc. v. Locations Le Carrefour Laval Inc., 2013 QCCA 1633 (CanLII), discusses two interesting issues relating to commercial leases:

1. What is the distinction between a legally binding promise to lease and a draft lease intended to serve only as a basis for negotiations?

2. What is the scope of the creditors’ obligations to minimize damages?

In 2008, Carrefour embarked on an expansion of its shopping centre and Europe expressed an interest in the location to open a new medical spa.

On March 10, 2009, the parties finalized a Letter of Intent (LOI) providing that:

(a) Carrefour will prepare a lease.

(b) The lease, once signed, will constitute a binding agreement.

(c) Nothing other than the signature of the lease will be binding on the parties.

(d) The LOI (once the conditions expressly made for the exclusive benefit of Carrefour are satisfied) will be legally binding.

Without waiting for the lease to be signed, Carrefour commenced substantial work to accommodate Europe in order to satisfy the delays and other requirements of the LOI with the knowledge and participation of Europe.

On August 20, 2009, Europe informed Carrefour that it would not sign a lease until the financing for which it applied is approved.

On October 26, 2009, Carrefour sent Europe a notice of default requesting compensation for damages namely, the cost of the leasehold improvements and lost future rent.

Carrefour thereupon commenced a search for a new tenant and eventually succeeded in leasing part of the premises for a period of 10 years commencing on January 1, 2011, leaving 6,000 sq. ft. still vacant as a result of Europe’s refusal to sign a lease.

It was not clear from the drafting of the LOI whether it was meant by the parties to be legally binding. Europe naturally argued that it never intended to be legally bound to Carrefour prior to signing a lease and that the LOI was a non-binding letter, the purpose of which was to form the basis for negotiations, but nothing more.

The Court of Appeal confirmed the decision of the court of first instance that the LOI was a legally binding promise to lease which Europe contravened, thereby exposing itself to a claim in damages. The evidence established that the LOI required the parties to sign a lease. It contained all of the essential elements of a lease namely, the description of the property, its intended use, the rent and the term. Notwithstanding the literal wording of the LOI, it was the role of the court to determine the common intention of the parties which, as determined by the Trial Judge, was that the LOI would constitute a legally binding agreement.

Although Carrefour won the battle to determine whether or not there was a legally binding commitment between the parties, it still had to prove that it suffered damages arising from Europe’s breach.

Europe argued that Carrefour did not satisfy its legal obligation to minimize its damages. Although the Trial Judge granted Carrefour damages for the costs incurred to modify the premises in accordance with the requirements of the LOI, the Trial Judge only granted Carrefour $184,000 out of the sum of $607,000 that it claimed for lost future rent.

The Trial Judge excluded 6,000 sq. ft. from his calculation because he found that had it not been for Europe, Carrefour would not have attempted to lease the space but instead would have kept it as storage space for its tenants.

Regarding the obligation to minimize damages, the Court of Appeal, referring to Articles 1479 and 1375 of the Quebec Civil Code, confirmed that the obligation to minimize damages is not absolute but rather is a duty imposed by law on the aggrieved party to use reasonable best efforts. The victim must act reasonably and diligently in order to minimize its damages. Furthermore, the burden is on the party in default to prove that the creditor, i.e. the party that suffered the prejudice, neglected or omitted to do all that it reasonably could or should have done in the circumstances to avoid or minimize damages.

Regarding the damages for lost future rent, the Court of Appeal did not agree with the Trial Judge’s findings. It reiterated the principle that in the event of a breach, compensatory damages are granted with a view to putting the victim in the situation that it would have been in had there been no breach.

Since the commercial space was built at the request of Europe, the Trial Judge should have determined the amount of rent that Carrefour was deprived of as a result of the breach by taking into account the entire area of the premises and not only a part.

Arguably, the fact that Carrefour committed itself financially to create the commercial space for Europe prior to signing the lease and that Europe was fully aware and actively participated in the process was very strong corroboration that the LOI was intended to be legally binding. In different circumstances, the Court might have chosen to apply a different principle in face of an ambiguous agreement with contradictory terms, namely that in the case of ambiguity, a contract should be interpreted in favour of the debtor of the obligation namely, Europe.

SELLER AND REAL ESTATE AGENT VICTIMS OF A SCAM

I found the facts of the decision rendered in Rivard v. Re/Max Fortin Delage Inc., 2014 QCCS 2109, shocking and wake-up call to both sellers and agents.

On June 26, 2006, the Seller of a high-end residential property in Quebec City entered into an exclusive listing agreement with an agent for a list price of $3,995,000.00.

On August 9, 2008, the Seller accepted an Offer to Purchase from Mr. Grenier for the price of $3,300,000.00. No deposit accompanied the Offer. However, one of the terms of the Offer provided that the Purchaser would provide the Seller with proof of funds within 10 working days.

During the course of the next few months, the Seller and the Agent became exasperated at the prospective Purchaser’s repeated delays in obtaining the funding necessary to consummate the transaction and by December, the Seller cancelled the Offer.

As a result of this disappointing experience, the Seller and the Agent agreed that in the future, any buyer who wished to visit the property would be required to prove a capacity to pay, and the MLS listing of the property was amended accordingly.

At the beginning of December 2009, Mr. Morin contacted the Agent to express his interest in the property. On December 11, 2009, Groupe Financier Banque TD sent a letter signed by the director of the branch to the Agent confirming that their clients, Mr. and Mrs. Morin, had accounts at the bank which had operated satisfactorily for a number of years.

On December 15, the Agent, the Seller and Mr. Morin met to sign an Offer to Purchase. Mr. Morin signed the Offer on behalf of an unidentified trust for a price of $3,300,000.00. No deposit accompanied the Offer, which contained a clause requiring the Buyer to provide proof of funding within 10 days. Mr. Morin introduced himself as a former director of Provigo and current owner of the building supplies company, Groupe Patrick Morin Inc. In the verification of identify form that he remitted to the Agent, he also declared that he was a director of Bombardier. At the meeting, he exhibited a document stating his investments had an aggregate value of $28,000,000.00.

On December 23, a letter was received by fax by the Agent from Groupe Financier TD signed by Carl Simard, Portfolio Manager of TD Waterhouse, attesting to the solvency of Mr. and Mrs. Morin to consummate the transaction for the price of $3,300,000.00. Because the letter attested that Mr. and Mrs. Morin had together the necessary funds and not Mr. Morin alone, the Agent thereupon communicated with the director of the branch who had signed the first letter and was told that she would inform Mr. Morin accordingly.

Thereafter, the closing date was repeatedly postponed. The arrival of the funds at the notary was delayed. Mr. Morin explained to the Agent that the source of the funds was HSBC Securities and that Mr. Jean Tremblay was handling the matter for him. On January 19, the Agent decided to communicate with Jean Tremblay, Vice-President at HSBC Securities. Mr. Tremblay replied in writing to the Agent that considering the tax consequences of the transaction, the date of closing had to be delayed once again.

Upon being informed of the contents of Mr. Tremblay’s letter, the Seller decided to call Mr. Tremblay directly and was informed that Mr. Tremblay did not know Mr. Morin personally although he had been referred to him by a financial advisor and he advised Mr. Morin that it would be a good idea to undertake a global analysis of the situation before proceeding further. Mr. Morin was not a client of HSBC and had no funds on deposit with it.

The Seller thereupon reviewed the solvency letter of December 22 and called the person who signed it, Mr. Simard, at the TD Canada Trust branch. He then learned that there was no such person at that branch. The Seller then searched for Mr. Simard on the Web and concluded that there was no Carl Simard who had any connection with TD Canada Trust. The Seller then realized that he had been the victim of a scam.

The Seller informed the Agent and the notary about his discovery. The notary informed the Seller that he had received a cheque from Mr. Morin dated January 1, 2010 in the amount of $3,300,000.00 with instructions not to deposit it until further notice.

A criminal complaint for fraud and use of counterfeit documents were brought against Mr. Morin. However, he was found not guilty due to successfully raising an insanity defense.

The Seller then sued the Buyer and the Agent in damages.

The Court concluded that the Buyer did not have the mental capacity to enter into a binding legal agreement, i.e. the Offer to Purchase and consequently could not be held civilly liable for his actions. Consequently, the Seller’s claim for damages against the Buyer was unsuccessful.

The analysis by the Court of the obligations of the Agent is of much greater interest.

The grounds of the suit against the Agent included the following:

1) She omitted to verify the capacity of the Buyer who signed the Promise as a representative of an undeclared trust and did not sufficiently inform the Seller of this detail.

2) She omitted to verify the information that she obtained relating to the solvency and financial resources of the Buyer and in particular, the contents of the solvency letters dated December 11 and 22, 2009.

3) She omitted to recommend to the Seller that he require a deposit on account.

4) The Agent installed a "sold" sign at the property before all of the conditions of the offer to purchase were satisfied.

5) She omitted to obtain Seller’s consent prior to publishing the news of the sale in the newspapers.

In its analysis of the Agent’s obligations to the Seller, the Court considered the following:

• Article 2100 of the Civil Code of Quebec provides that whoever contracts to provide services must act in the best interests of the client and with prudence and diligence;

• Sections 1 and 22 of the Real Estate Agents and Brokers Code of Ethics provides that agents and brokers shall practice their profession with prudence, diligence and competence.

To successfully defend herself against the claim, the Agent had to prove that she provided her services with prudence and skill. Diligence is determined on the basis of what a reasonable professional would do in similar circumstances.

The Agent had twenty years of experience selling high-end residences and promoted herself as such. Although she had undertaken to ensure that she would obtain a solvency letter prior to allowing a Buyer to visit the property, she failed to do so. Moreover, the first solvency letter was insubstantial and far short of confirming that Mr. Morin had sufficient financial resources to complete the sale.

When the parties met to sign the Offer to Purchase, the Seller knew that no solvency letter existed although one of the conditions in the Offer required the Buyer to provide such a letter within ten days.

The Court noted that the Seller was a sophisticated person who had been involved over a number of years as a shareholder investor and in the governance of an important information technology consulting business. He had been president of the business for a period of twelve years. His duties included prospecting new acquisitions for the business and business development. He was a sophisticated businessman who accepted the Offer to Purchase without requiring a solvency letter and should be presumed to know what he was doing.

An element that the Court found particularly striking was the failure of the Agent to verify the unidentified trust that Mr. Morin was representing. By accepting to sell to an unidentified trust, the Seller exposed himself to the risk that Mr. Morin would not have the authorization to legally bind the trust.

Regarding the solvency letter of December 22 purportedly signed by Mr. Simard, instead of contacting Mr. Simard, the Agent contacted Mme Dalaire, the director of the Branch. The Court concluded that this was difficult to understand and contrary to good sense, which would have required the Agent to use her best efforts to communicate with the author of the letter, who would be the best source of information and knowledge regarding the financial accounts of the prospective Buyer and his wife that the letter referred to.

The Court stated that the obligations of prudence and diligence to which brokers and agents are held, require that they take cognizance of such solvency letters and they verify that they are valid and binding. If the Agent would have done a proper verification in a timely fashion, she would have immediately discovered that it was counterfeit. The Court was also surprised that although the Buyer had significant mental problems, the Agent made no effort to verify his representations that he was a former officer of Provigo, owner of Groupe Patrick Morin and a director of Bombardier with investments of $28M. Basic curiosity if not prudence would have required some follow-up verification with respect to such representations in the context of such an important transaction.

In fact, the Agent relied exclusively on information provided to her verbally by the Buyer and the two solvency letters from TD Canada Trust, which were all false.

The Court also referred to Article 2102 of the Civil Code of Quebec which requires a supplier of services to provide the client with all useful information relating to the services to be provided.
The supplier of services could be held responsible for providing the client with false information if he did not sufficiently verify the information that he provided, such as the solvency of the prospective buyer.

Although not a guarantor of the solvency of the buyer, the Court was of the opinion that a real estate agent has the obligation to present a buyer who is honest and solvent, and to verify the seriousness, honesty and solvency of the buyer.

When the Seller was provided with the solvency letter and informed by the Agent that the condition had been accomplished and the Offer to Purchase became irrevocable, he had every reason to feel secure in the transaction.

The sham was discovered within a few minutes by the Seller because the Agent didn’t do her job properly. The Court concluded that the Agent committed many faults with respect to her obligations pursuant to the listing agreement and was liable for the damages that the Seller was able to prove.

The facts of this case remind stakeholders in business transactions not to presume or take important matters for granted. The letter of the law says that all persons are presumed to act in good faith. However, the parties as well as their legal advisors must balance trust with a certain degree of skepticism. As the saying goes, trust but verify.

What Common Area Expenses Can the Landlord Pass On to the Net Lease Tenant?

Although there are certain standard practices that are common to most commercial leases, the landlord and tenant may negotiate terms that derogate from them.

A frequent concern is the tenant’s proportionate share of the common area maintenance ("CAM"). Usually, expenses of a capital nature that are incurred are considered to be the sole responsibility of the landlord and are excluded. Frequently, the lease may refer to accepted accounting practice for the definition of a capital expense. According to the Canadian Institute of Chartered Accountants (CICA) Handbook, whether an expense can be considered as a capital expense is dependent upon whether the service potential of the asset was enhanced and not simply maintained. An interesting discussion of the issue is found in the Ontario Superior Court of Justice decision in RioCan Holdings Inc. v. Metro Ontario Real Estate Limited, 2012 ONSC 1819.

In 2002, RioCan resurfaced the pavement of the parking lot at its shopping centre in order to correct some cracking and distress created by wear and tear of traffic and the elements. It then charged the tenant its proportionate share of the cost, amortized over 20 years, as part of the additional rent. From 2003 to 2006, the tenant’s predecessor paid the charges without complaint. However, in 2007/2008, the tenant decided that it would no longer be responsible for such costs because it considered them be capital in nature.

In 2002, the parking lot was "rehabilitated" by a process that involved pulverizing the asphalt and underlying granular base, compacting it, and adding a new layer of hot mix. RioCan amortized the cost ($431,000) over 20 years with the intention of passing it on to the tenants as additional rent.

In addition to engaging expert pavement and asphalt engineers to explain the nature of the "rehabilitation" and its consequences, the parties also retained accountants to assist the Court in deciding whether the cost ought to be capitalized in accordance with Generally Accepted Accounting Principles ("GAAP") or whether it was also appropriate to apply or seek inspiration from income tax accounting principles. Both accountants agreed that GAAP does not encompass tax accounting practices but the latter could nevertheless be useful because it uses the term "capital" while GAAP uses different terms such as "betterment".

According to RioCan, if an expenditure resulted in an enhancement of the expected future economic benefit to the owner, then such an expense would be a capital or betterment expense. To word it differently, RioCan would ask the question: Will the expenditure lead directly or indirectly to increased future net cash flows, i.e. an increase to rental income? If so then it should be treated as a capital expense. On the other hand, if the expenditure has the limited effect of maintaining an asset in operational condition, then such expenditure should properly be considered a repair which could be recovered from the tenants.

The tenant argued that the life span of the parking lot pavement was significantly extended by the expenditure thereby resulting in "enhanced service potential" of the parking lot.

RioCan argued that the relevant asset is not the parking lot but the shopping centre as a whole and there was no future economic benefit to RioCan resulting from the expenditure, i.e. the rents that were required to be paid were not affected and since the centre was fully leased at the time, there was no reasonable expectation of increased rent as a result of the expenditure.

The tenant’s engineer was of the opinion that the process used by RioCan, which consisted of breaking up the asphalt, mixing it and reusing it with the existing base, significantly extended the life span of the pavement by as much as 18 years. The tenant’s engineer described the process as "major rehabilitation" and not a "repair". The process used by RioCan and known in the industry as "IPP" is a relatively recent technique, i.e. subsequent to the 1980’s. The IPP process involves grading and compacting the mixture of asphalt and underlying granular material to form a new superior foundation.

The Court found that the expenditure caused the parking lot to be "as good as new", significantly extended its life and significantly decreased the operating costs of the parking lot. The Court noted that these are factors considered in the CICA Handbook for the determination as to whether the service potential of an asset has been enhanced and should be treated as a "betterment".

The Court accepted the tenant’s argument that although RioCan unilaterally amortized the expenditure over 20 years, there was nothing in the lease that required it to do so. Ordinarily, only capital costs are amortized not maintenance costs. Consequently, the tenant successfully argued that for RioCan to succeed, it must persuade the Court that it was permitted to charge its tenants the entire amount of the expenditure as a lump sum in the year that it was incurred. In other words, RioCan by unilaterally amortizing the expenditure, implicitly acknowledged that it was capital in nature.

The Court noted that although the engineering expert evidence submitted by the parties was reasonably consistent, the accountants differed in their conclusions as to whether the expenditure was capital or maintenance, mainly as a result of their disagreement regarding whether the shopping centre or the parking lot should be considered the relevant asset.

The Court found on the evidence that the rehabilitation of the parking lot was a significant capital project and not mundane, such as fixing potholes or painting lines, and which had the effect of reducing operating expenses and extending the life of the parking lot.

The Court rejected RioCan’s argument that the expenditure had no impact on the estimated life of the shopping centre taken as a whole. The Court found the argument to be illogical since otherwise, any capital expenditure for the parking lot, even a full demolition and rebuild, would never extend the life of the shopping centre as a whole.

The Court preferred the approach of the tenant that the parking lot is a component of the overall property and where an expenditure is incurred that results in a significant increase in the useful life of a component of the leased property, there is also an increase in the useful life of the leased property as a whole and of its service potential. The Court also agreed that there are economic benefits resulting from the expenditure on a parking lot that will extend its useful life as compared with a deteriorated parking lot.

In addition, the Court concluded that in determining whether an expenditure is capital in nature, it is not necessary to attempt to match a particular revenue with the improved assets and that indirect relationships are sufficient.

Examples of such indirect relationships that the Court gave include:

(a) Complying with the landlord’s lease obligations and thereby avoiding claims by its tenants;

(b) Retaining existing tenants;

(c) Attracting new tenants;

(d) Obtaining additional rent to the extent the landlord is entitled to rent as a percentage of the tenants’ sales and sales increase because of the quality of the property;

(e) Enhancing the economic value of the property, and

(f) Avoidance of possible claims from visitors to the property relating to injuries sustained in the parking lot.

Finally, the Court noted that expenses of a capital nature are not clearly defined in the case law and will depend on the particular facts of each case.

Conclusion

Legal counsel are continually being challenged by the acceleration of innovation in our society. While this is arguably more pronounced in the intellectual property domain, this case illustrates that the same is true in a more traditional “bricks and mortar” area of the law.

New technology is testing common definitions that are generally used but have not been updated in a timely manner. The definitions and interpretation of terms such as capital or maintenance are being challenged with the potential of having significant financial impact on the parties to a commercial lease.

Legal counsel should not overlook the importance of drafting clear definitions for important terms in commercial leases that risk being the potential source of costly litigation.

LIABILITY OF THE PROPERTY MANAGER

What are the legal obligations of a property manager who is given sole discretion by the owner to carry out repairs as the latter deems necessary for the maintenance and preservation of the property?

In the Quebec Court of Appeal decision of Monit Management Limited v. Samen Investments Inc., 2012 QCCA 1821, the owner of a commercial building sued the property manager for gross negligence for omitting to perform regular maintenance and repairs to the concrete parking area.

The manager acknowledged that it kept the repairs and maintenance to a minimum in accordance with the owner’s directives to minimize expenses and maximize profits. The manager added that the owner benefited from the manager’s administration since had more been spent for maintenance and repairs, the owner would have received less profit.

The property management contract was in effect from 1976 to 2003, a period of 27 years. At the end of the contract, the owner decided to hire a different property manager who conducted an inspection of the property with a view to upgrading the building from a Class C to a Class B property. At that point, it was discovered that the concrete parking area had become structurally unsound. The evidence established that the concrete would have had to be replaced eventually, but the lack of timely maintenance on the part of the manager shortened the useful life of the structure.

Not only did the property management contract grant the manager sole discretion with respect to the necessity of maintenance and repairs but it also included an exoneration clause that shielded the manager from all liability other than for damages resulting from its willful misconduct or gross negligence.

Both the Superior Court and Court of Appeal sided with the owner. The argument of the manager that the owner could not question the manager’s discretion regarding the necessity of repairs and maintenance was rejected on the ground that the discretion of the manager was not absolute but was tempered by a fundamental obligation of the management contract to act as a prudent administrator and to perform its duties with due diligence. The Court reasoned that to allow the manager to exculpate itself on the ground that it enjoyed exclusive and absolute discretion would have rendered inoperative a fundamental contractual obligation of the manager. In a contract, the obligations are mutually dependent and it would do violence to the existence of the contract to interpret the obligations of one of the contracting parties as being merely voluntary and therefore legally unenforceable.

The Court also noted that it was the property manager who drafted the agreement and that any ambiguity regarding its interpretation should weigh in favour of the owner.

Another argument advanced by the manager was that since it was an experienced property manager who, at all relevant times, managed between 25 and 50 commercial properties, it could not possibly be guilty of gross negligence. This argument was obviously given little weight.

In order to succeed in the face of the exoneration clause, it was essential that the owner convince the Court that the manager was not merely negligent, but was guilty of willful misconduct or gross negligence.

Two factors contributed to the Court’s conclusion that the lack of maintenance of the underground parking area constituted gross negligence. The first factor was the long period of time during which the manager neglected to maintain and preserve the property. The second factor was that the manager knew or should have known the consequence that a lack of maintenance and repair would have on the concrete structure. More particularly, the evidence established that during the duration of the contract, the manager was aware that small pieces of concrete were detaching from the structure from time to time and causing minor damage to parked automobiles. The property manager even had a tarpaulin installed to protect parked cars from water infiltration and falling bits of concrete.

The manager also argued that even if the Court concluded that it was grossly negligent, since the underground parking area was old and would have had to have been redone anyway, and the owner’s revenues during the term of the contract were higher than they would otherwise have been due to low maintenance and repair costs, the owner incurred no prejudice.

Not surprisingly the owner saw things differently and argued that there was a cost involved in having to rebuild the underground garage earlier than necessary. Moreover, the owner argued that had the necessary maintenance and repairs been carried out during the term of the contract, such costs could have been passed on to and recovered from the tenants as part of their proportionate share of the operating expenses. The cost of rebuilding, as opposed to maintaining, is not an expense that can usually be passed on to tenants.

Once again, the Court sided with the owner despite the fact that the proof of quantum of damages was unclear. In the circumstances, the Court used its discretion to arbitrate an amount, $170,000.00, which was substantially less than the amount of $743,000.00 that the owner claimed.

An additional factor that may have influenced the outcome was that the property was owned by an absentee owner who resided in Italy. Moreover, the president of the owner, an accountant by profession, resided in Switzerland. Arguably, the Court may have held the manager to a slightly stricter standard than might have otherwise been the case since the evidence established that the owner and/or its president were only rarely physically present in Quebec, were primarily focused on the financial aspects of their investment and relied heavily upon the manager to take care of the property.

Again, reading between the lines, one might argue that in a contractual relationship, each party may have certain reasonable expectations which if not met, could result in the other party being considered in breach of contract and liable to indemnify the party whose expectations it failed to meet.

OFFER TO PURCHASE CONDITIONAL UPON MORTGAGE FINANCING APPROVAL

If an offer to purchase is conditional upon the purchaser obtaining financing, which fails to materialize, can the purchaser cancel the deal?

The Quebec Court of Appeal decision in Hazan et al. v. Madeco Mascouche Inc., 2012 QCCA 2056, provides an informative illustration.

The facts of the case can be summarized as follows:

• The purchaser and seller signed an offer to purchase a building to be built by the seller.

• The offer to purchase was conditional upon the purchaser obtaining financing.

• The financing was approved subject to the condition that at the time of disbursement, leases shall have been concluded with an aggregate rent of at least $22,800.

• Seven weeks after the financing was conditionally approved, the lender unilaterally changed the condition to add a ten percent withholding requirement until the property is fully leased.

• The purchaser never objected to the change in condition nor did he inform the seller.

• The purchaser paid a deposit to the seller as well as progress payments according to the completion of various stages of construction as prescribed in the offer to purchase.

• The purchaser refused to sign the deed of sale within the stipulated delay due to the refusal of the lender to disburse the financing on the ground that the conditions for financing were not fully satisfied.

• Due to his inability to obtain financing, the purchaser claimed cancellation of the deal as well as reimbursement of his deposit and all progress payments that he had paid to the seller.

Based on the evidence, the Court found that the purchaser had not made any serious effort to lease the property, which was a condition precedent required by the lender. The purchaser’s attitude was described by the Court as tentative and passive, which it considered to amount to negligence and was in contrast to the proactive, diligent attitude that was recognized by the case law as being required in similar situations.

In effect, although the sale was conditional upon the purchaser obtaining financing, a contracting party is required by law to act diligently and in good faith with respect to the performance of his contractual obligations, including actively taking all reasonable means to perform his obligations and satisfy any conditions precedent upon which his obligations depend.

Furthermore, based on the evidence, the Court concluded that the purchaser never had the financial means to acquire the property and was at all relevant times, financially stretched to the limit. In the words of the Court, the purchaser entered into the contract to purchase in the same manner as houses were recently being built in Spain i.e. irresponsibly.

When a contract is cancelled, the law requires that the parties, to the extent reasonably possible, should be financially restored to the situation that they were in immediately prior to concluding the contract. The purchaser relied on this principle as the basis for his claim for reimbursement of the deposit and progress payments. However, as is often the case, the offer to purchase included a penal clause which allowed the seller to retain all amounts that it received up until the termination of the contract, in the event of the purchaser’s default. Moreover, purchaser made no effort to attack the validity of the penal clause on the ground that it was abusive.

Who Is Responsible for Latent Defects in a Property?

Article 1726 Civil Code of Quebec states that "The seller is bound to warrant the buyer that the property and its accessories are, at the time of the sale, free of latent defects which 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 if he had been aware of them."

In order for the buyer to succeed, his claim must satisfy the following conditions:

1. The defects must be hidden;
2. They must have existed at the time of the sale, and
3. Notice of the latent defects must be given to the seller within a reasonable delay.

Occasionally, some defects may take years or even decades to manifest themselves. Hypothetically, a building may be constructed with materials or techniques that are recognized as acceptable at the time of construction but years later may subsequently be determined to be toxic, hazardous or unsound. What are the recourses of a buyer in such circumstances?

The legal warranty of quality applies to every sale by default, whether or not it is written into the contract, unless it is expressly excluded by the parties. It is an accessory to the sale contract and by virtue of Article 1442 of the Civil Code, the warranty automatically follows the property and transfers to successive buyers. The practical implication of this is that a buyer may not only sue his immediate seller, but may also sue anterior sellers as far back as the latent defect existed. Moreover, each seller can sue his anterior seller(s) to claim indemnification for any condemnation that may be rendered in favour of the ultimate buyer.

Of course, the recourses are predicated upon notice being given to the anterior seller(s) within a reasonable delay of the discovery of the defect.

The right to pursue previous sellers may have practical advantages for a buyer when the immediate seller has disappeared or is insolvent. Moreover, even if the buyer waived and renounced the legal warranty of quality vis-à-vis his immediate seller, he could still pursue one or more anterior sellers.

Assuming that the buyer will not agree to waive the benefit of the warranty, the seller should insist that the warranty will be limited to the immediate buyer and not transferrable to successors in title. Alternatively, the parties could stipulate in the sale contract that the warranty shall lapse and be null and void after a certain period of time e.g. 3 years.

For an illustration, see Riendeau v. Guy Brière Courtier d’assurances Inc., 2012 QCCS 6071.