Good Business Sense

WeirFoulds LLP Leasing Update - Winter 2009 | JANUARY 1, 2009
Lisa Borsook

"Latent Ambiguity" and Good Business Sense

The Ontario Superior Court of Justice and Court of Appeal's recent decision in Calloway Reit (Westgate) Inc. v. Michaels of Canada, ULC ("Calloway") is a shot across the bow for tenants seeking to avoid rent when in possession of the premises, open for business and accepting the services of the landlord. Calloway suggests that the courts are unafraid to use the tools of contractual interpretation to arrive at a result that makes sense and ensures a fair result. Landlords and tenants, particularly sophisticated entities, should carefully consider industry standards and past conduct before pursuing a contentious course of action and relying solely on their lease. In this case, the courts clearly held no sympathy for the tenant seeking to completely avoid its obligation to pay rent nearly 1½ years after taking possession and operating on the premises.

The Facts of Calloway

The parties entered into a shopping centre lease on December 19, 2005 (the "Lease"). On July 5, 2007, Michaels of Canada, ULC (the "Tenant") took possession of the premises and opened for business but did not pay rent. Calloway REIT (Westgate) (the "Landlord") commenced this action on November 21, 2008, as a result of the Tenant's continuous refusal to pay rent.

The Lease (the Tenant's standard form) provided that rent accrued from the rental commencement date, which could not occur until the Landlord fulfilled its construction obligations in accordance with the completion date. The Tenant took the position that this meant all buildings in the shopping centre had to be constructed before rent was owed. As at November 2008, the shopping centre was 90% complete.

At first instance, the application judge engaged in a factual analysis to determine the "general context that gave birth to the document". The court concluded that the interpretation argued by the Tenant did not accord with good business sense for several reasons. First, the Tenant was aware that the shopping centre was proceeding as a phased development project. Moreover, under the Lease, Wal-Mart was the only tenant that was required to be open for business as a condition of the Tenant's obligation to pay rent. Second, nine previous leases negotiated by the Tenant, in respect of phased development projects, contained the same provisions – but the Tenant had commenced paying rent for those premises, well before all of the buildings in those respective shopping centres were fully built out. Third, the judge found internal inconsistencies within the Lease that favoured the Landlord's interpretation that the shopping centre need not be fully constructed to trigger the Tenant's rental obligations. The application judge then aptly highlighted the absurd practical effect of the Tenant's position that, if allowed, would permit it to "occupy the Premises, rent-free, until the Shopping Centre is fully completed, despite itself being fully operational . . .".

The Court of Appeal Decision

In a unanimous decision, the Court of Appeal dismissed the appeal and ordered costs against the Tenant. Unlike the lower court, the Court of Appeal resolved the issues on appeal using contract interpretation principles alone. The Court of Appeal accepted the application judge's finding of internal inconsistencies within the Lease and invoked the doctrine of "latent ambiguity" to put the matter at an end. The doctrine, briefly stated, requires that an interpretation of an agreement must accord with good business sense, and avoid commercial absurdity. The ambiguity is latent because it is usually not obvious on the face of the document, and only arises when there is conflict with the evolving factual circumstances. In applying the doctrine, the Court of Appeal determined that it was not commercially reasonable to interpret the completion date and rental commencement date in such a way that would allow the Tenant to take possession, carry on business, and avail itself of the common elements and other services of the Landlord, but not pay rent. The Court of Appeal went on to conclude that the Tenant's conduct in the circumstances effectively waived strict compliance by the Landlord with its construction obligations as a condition triggering the Tenant's rent obligations.

Waiver and latent ambiguity – tools to think about when you don't like what the contract has to say.