The Impact of a Sublease on the Relationship Between a Commercial Landlord and a Tenant

The Ontario Court of Appeal recently issued a decision that considered the fundamental issues regarding the nature and operation of commercial tenancies and, in particular, the impact of a sublease on the relationship between landlord and tenant.

What Happened?

The tenant operated a retail clothing business in Toronto. The landlord owned the premises, which were located on Bay Street. 

In September 2010, the tenant entered into an agreement with the landlord to lease the premises. The initial term of the agreement was seven years, commencing October 1, 2010 and expiring September 30, 2017. There was also a five-year renewal option for the tenant set out in the agreement. The landlord and the tenant entered into a formal lease on October 1, 2012. 

In August 2016, with the landlord’s consent, the tenant entered into a sublease with a retail clothing store. The term of the sublease was from September 1, 2016 to September 30, 2017. The sublease did not reserve the last day of the head lease’s term to the tenant; instead, the head lease and the sublease were set to expire on the same day. In the sublease agreement, the tenant expressly exempted and excluded the five-year renewal term.

On March 2, 2017, the tenant purported to exercise its right to renew the lease for a further five-year term. The tenant and the landlord began negotiating rent through email exchanges but could not agree on a new rental rate. 

On September 28, 2017, counsel for the landlord delivered a letter to the tenant stating it had no right to exercise the five-year renewal option. The lease expired on September 30, 2017. Pursuant to an arrangement with the landlord, the sublessee remained in possession of the premises after the sublease ended. The sublessee paid the landlord the same rent it had previously paid under the sublease.

The tenant commenced an application seeking, among others, a declaration that it had rightfully exercised its option to a five-year renewal of its lease starting October 1, 2017.

The application judge ruled that the tenant had a claim for breach of contract against the landlord, but that it had suffered no damages. He therefore dismissed the application.

Court of Appeal Decision

The court considered the nature of a commercial lease, the common law rule regarding the failure to reserve the last day of a sublease, case law that has expanded the notion of a reversionary interest, s. 3 of the Commercial Tenancies Act (“CTA”), and how s. 3 impacts the common law. 

The court focussed on the fact that neither party had raised the issue of s. 3 of the CTA, which states:

3. The relation of landlord and tenant does not depend on tenure, and a reversion in the lessor is not necessary in order to create the relation of landlord and tenant, or to make applicable the incidents by law belonging to that relation; nor is it necessary, in order to give a landlord the right of distress, that there is an agreement for that purpose between the parties. 

The court explained that s. 3 stipulates four “negatives”:

(1)  The relation of landlord and tenant does not depend on tenure;

(2)  A reversion in the lessor is not necessary in order to create the relation of landlord and tenant;

(3)  A reversion in the lessor is not necessary in order to make applicable the incidents by law belonging to the landlord-tenant relation; and

(4)  An agreement is not necessary in order to give a landlord a right of distress.

The court then explored the impact of s. 3 on the common law, stating:

“Reading s. 3 in context, I interpret it to mean that there may be a sublease even if the last day in the head lease is not reserved, but only when there is sufficient evidence to show that the objective intention of the parties, as reflected in the sublease, was not to create an assignment. Recognizing that a commercial lease is not only a conveyance but also a contract, courts should be permitted to consider the objective intentions of the parties to a purported sublease in order to determine the nature of the impact on the subletting party vis-à-vis its rights under the head lease. In other words, a party may demonstrate that, notwithstanding a failure to reserve the last day of the head lease term, an assignment was not intended by the parties.”

The court found that, because the tenant had failed to reserve to itself the last day of the head lease term, the purported sublease would have operated as an assignment in the absence of s. 3 of the CTA.

However, the court found that the sublease provided sufficient evidence to show an intention to maintain a landlord and tenant relationship between the parties. 

Accordingly, the court held that the tenant had the right to renew the lease provided that it exercised its renewal right in accordance with the terms of the lease, which the court found that it did. 

As a result, the court allowed the appeal and set aside the judgment of the application judge.

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