The Importance to Tenants of Non-Disturbance Agreements from Prior-Ranking Mortgagees

A recent Ontario Superior Court decision has confirmed that when a commercial landlord defaults on its mortgage, a tenant may be at risk of losing the protection afforded by its lease, and might face eviction.

In Purenergy Wellness Lofts Corporation v. Home Trust Company, 2018 ONSC 4723 a landlord defaulted on its mortgage and the mortgagee took possession of the property. The mortgagee subsequently assigned the mortgage to a second mortgagee who in turn gave the tenant notice of termination of its tenancy based on building code violations.

In response, the tenant commenced an application for relief from forfeiture. The court refused to grant relief from forfeiture and stated that the termination was lawful.  The court held that the mortgagee was not bound by the lease and, consequently, the tenant was on a year-to-year tenancy. As a result, the tenancy could be terminated on six months’ notice and relief from forfeiture was not available.

The Facts

In August 2014, Purenergy Wellness Lofts Corp. (the “Tenant”) entered into a verbal agreement to rent premises from 333 Bering Ave Inc. (the “Landlord”). After obtaining possession, the Tenant performed extensive renovations, which cost over $154,000. On February 1, 2017, the parties entered into a written lease (the “Lease”).  In July 2016, the Landlord obtained a mortgage on the property from Cameron Stephens Financial Corporation (the “First Mortgagee”). Several months later the Landlord defaulted on the mortgage and the First Mortgagee obtained a judgment for possession of the property. During the mortgage enforcement proceedings, the First Mortgagee and the Tenant came to an agreement allowing the Tenant to remain in possession of the premises, though the terms of their agreement were in dispute.

In November 2017, the First Mortgagee transferred its interest in the mortgage and the property to Home Trust Company (the “Second Mortgagee”). The Tenant began paying rent to the Second Mortgagee.  On March 23, 2018, the Second Mortgagee gave notice to the Tenant that it was required to vacate the premises in one week due to building code violations.

The Tenant commenced a court application and argued that the Lease was valid and binding on the Second Mortgagee and therefore the termination was invalid. Alternatively, the Tenant argued that it had a year-to-year tenancy and the earliest date that the tenancy could be terminated was October 31, 2019. As a further alternative, the Tenant argued that it was entitled to relief from forfeiture.

The Court disagreed with the Tenant and found that the Lease was not binding on the Second Mortgagee. The Court noted that where a mortgagor defaults on a mortgage and a mortgagee takes possession of a property, the mortgagee does not necessarily step into the borrower’s shoes with regard to a commercial lease. The Court held that a lease will not be binding on a mortgagee who takes possession of a property following a default unless the mortgagee consented to and was aware of the lease when the mortgage was obtained. Notwithstanding this, the tenant and mortgagee may still create a tenancy by agreement or conduct.

The Court found that there was only a verbal agreement between the Tenant and the Landlord at the time the Landlord obtained the mortgage and the actual Lease was entered into after the mortgage was obtained. The Court also found no evidence that the First Mortgagee was aware of the verbal agreement between the Landlord and the Tenant, or that it consented to the Lease.  The Court therefore concluded that the Lease was not binding on the First or Second Mortgagees.

Nonetheless, the Court agreed with the Tenant that it had a year-to-year tenancy, despite the Second Mortgagee’s claim that there was a month-to-month tenancy. The Second Mortgagee argued that the Tenant agreed to a month-to-month tenancy because the Second Mortgagee had sent the Tenant an email in which it stated that the tenancy would be month-to-month, and furthermore, that it could not guarantee a purchaser would assume the tenancy and the Tenant had responded “Acknowledged, thank you”. The Court held that this acknowledgement was insufficient evidence that the Tenant agreed to a month-to-month tenancy and held that the tenancy was year-to-year and therefore could only be terminated on six months’ notice.

Interestingly, the Court also stated that the notice of termination for building code violations was not a valid ground for termination.  However, the notice of termination was nevertheless held to be valid, as it accomplished its underlying purpose of notifying the Tenant that its tenancy would be terminated. As notice of termination was validly given, the Court ordered that the Second Mortgagee was entitled to terminate the Tenant’s tenancy on October 31, 2018, just over six months after the notice was initially given.

The Tenant was also denied relief from forfeiture. The Court held that where a tenancy is found to be year-to-year, all that is required to terminate the tenancy is six months’ notice given to the tenant. If this notice is received, relief from forfeiture cannot be applied to protect the tenant.

The Takeaway

This case illustrates just how important it is for tenants to obtain a non-disturbance agreement. A non-disturbance agreement is an agreement between the tenant and the landlord’s lender that permits the tenant to remain in possession of the leased premises, pursuant to the terms of the lease, despite any foreclosure action against the landlord. If a non-disturbance agreement had been executed in this case, the result might have been quite different.