Ontario Court Of Appeal Clarifies Interplay Between Lease Abandonment and Subtenancy

A recent decision from the Ontario Court of Appeal has upheld the effect of a lease abandonment on a subsisting sublease.  In Smiles First Corporation v. 2377087 Ontario Limited (International Union of Painters), 2018 ONCA 524, the court upheld the rule that a surrender of a head lease to the landlord will not extinguish any subleases created by the surrendering tenant.

The court held that, even though a subtenant attempted to take an unlawful assignment of the head lease and failed to honour an agreement with the landlord, it was still entitled to relief from forfeiture as a subtenant.  The court clarified that the subtenant did not obtain a lawful assignment of the head lease when the head tenant abandoned the premises.  However, the surrender of the head lease did not result in the termination of the sublease and the subtenant was therefore permitted to remain in the premises on the terms of the sublease.

The Facts

In January, 2015, the tenant (the “Head Tenant”) signed a lease (the “Lease”) from the landlord for commercial premises (the “Premises”).  The Lease was for a term of five-and-a-half years commencing on February 1, 2015 (the “Term”).  The Lease contained terms which stated that it could not be assigned without the landlord’s consent and the Head Tenant could not enter into an assignment agreement if it was in default of the Lease.

On February 1, 2015, Smiles First Corp. (the “Subtenant”) subleased the Premises from the Head Tenant by way of a letter of intent (the “Sublease”).  Under the Sublease, the Subtenant agreed to pay a significantly higher rate than the Head Tenant was paying to the Landlord under the Lease.

In mid-2016 disputes arose between all of the parties under both the Head Lease and Sublease.  In October, 2016 the Subtenant and the Head Tenant informed the landlord that they had entered into a tentative agreement to resolve their ongoing dispute.  However, the agreement was contingent on the landlord`s approval of the assignment of the Head Lease to the Subtenant and/or entering into a new Head Lease with the Subtenant.

On October 31, 2016, the Head Tenant and the Subtenant executed an assignment agreement (the “Assignment”), whereby all of the rights under the Head Lease were assigned to the Subtenant.  Neither the Head Tenant nor the Subtenant requested the landlord’s consent to the Assignment, contrary to the terms of the Head Lease.

At the same time, the parties entered into three-way negotiations to resolve their ongoing issues.  The Landlord wanted to enter into a new head lease with the Subtenant and the Head Tenant wanted to withdraw from the Premises and the Head Lease permanently.

In November, 2016, the landlord circulated a settlement agreement to the Head Tenant and the Subtenant, whereby the Subtenant would enter into a new Head Lease with the landlord and the Head Tenant would exit the Premises permanently.  The Head Tenant signed the agreement and it was agreed that it had abandoned the Head Lease as of November 1, 2016.  The Subtenant did not sign the settlement agreement, but it began paying rent directly to the landlord after November, 2016 and its rent payments were accepted by the Landlord.

In February, 2017, the Landlord reminded the Subtenant that it had yet to sign the settlement agreement or enter into a new head lease with the landlord.  The Subtenant refused to sign the agreement and it was not able to enter into a new head lease with the landlord on terms that were acceptable to both parties.

The Subtenant then argued that it was an “official tenant” under the Head Lease by virtue of the Assignment.  The landlord stated that the Assignment was invalid due to the fact that it had not consented to the assignment and, as such, the Subtenant was occupying the premises on a month-to-month basis.

On March 21, 2017, the landlord provided the Subtenant with a termination notice which stated that its tenancy would end on April 30, 2017.

The Application

Following the termination, the Subtenant commenced an application seeking a declaration that the Assignment was binding and enforceable.  In the alternative, the Subtenant also sought relief from forfeiture.

The application judge held that the Assignment was invalid for a number of reasons. Most notably, neither the Head Tenant nor the Subtenant obtained the landlord’s consent to the Assignment, contrary to the terms of the Head Lease.

The Subtenant also argued that, even if the assignment was invalid, the landlord acknowledged that the Head Lease was equitably assigned to the Tenant by accepting rent from the Tenant after the Head Tenant abandoned the Premises.  The application judge also rejected this argument and held that rent was accepted by the landlord during a period when it had made it clear to the Subtenant that it needed to enter into new head lease directly with the landlord.  The Subtenant was not prepared to enter into such a lease on terms that were favourable to the landlord.  It was therefore held that acceptance of rent during this period did constitute an equitable assignment, nor did it amount to a waiver of the landlord’s rights.

In terms of the relief from forfeiture argument, the application judge held that the Subtenant was not entitled to relief from forfeiture because the landlord did not attempt to enforce a right of re-entry under the Head Lease, which was abandoned by the Head Tenant.  Consequently, the Subtenant was not entitled to an order allowing it to remain in the Premises as a subtenant on the terms and conditions of the Head Lease.

Interestingly, the application judge held that, because the Subtenant was attempting to enter into a new lease with the Landlord after Head Tenant abandoned the Head Lease, the Subtenant was not taking the position that it was a valid subtenant at the time.  It was also held that the abandonment of the Head Lease resulted in the termination of the Sublease.  As such, the application judge concluded that the Subtenant was not entitled to relief from forfeiture as a subtenant, due to the fat that it was not a valid subtenant at the time.

The Appeal

The court of appeal upheld the application judge’s decision regarding the Assignment.  It was therefore affirmed that the Assignment was invalid and the Head Lease was not equitably assigned.

The court of appeal also ruled that the application judge was correct in finding that the Head Tenant abandoned the Head Lease as part of its settlement with the landlord.  However, the court also concluded that the application judge erred in accepting the landlord’s argument that the surrender of the Head Lease resulted in the termination of the Sublease.

It was explained by the court of appeal that that the law in this area is well settled.  Citing the decisions of Kowalski and Shoota v. Gale, 1946 CanLII 313 (ON CA), [1947] 1 D.L.R. 354 

(Ont. C.A.), Shapiro v. Handelman, 1947 CanLII 90 (ON CA), [1947] O.R. 223 (C.A.) and Royal Bank v. Loeb Inc., [1995] O.J. No. 1702 (Gen. Div.), as well as section 17 of the Commercial Tenancies Act, the court claried that, when a tenant surrenders a head lease to a landlord, the subleases created by the surrendering tenant survive until the end of their respective terms.

The court of appeal ruled that the application judge erred in finding that the Subtenant did not retain its subtenancy when the landlord served the notice of termination.  However, the court of appeal also made it clear that the application judge was incorrect to rule that the Subtenant was entitled to remain in the Premises on the same terms as the Head Lease.  Rather, the Subtenant was only entitled to remain in the Premises under the Sublease.

Accordingly, the Subtenant was granted an order for relief from forfeiture against the Landlord`s attempt to terminate its possession of the Premises on the basis that it was merely a monthly tenant.  When the termination notice was delivered, the Subtenant was not occupying the Premises on a month-to-month basis.  It was deemed to be a lawful subtenant at the time and it was therefore entitled to remain in the Premises under the Terms of the Sublease.

The notice of termination was therefore held to be of no force and effect.  In the end, the court of appeal granted the Subtenant a declaration that it is entitled to remain in possession of the Premises until the end of the term of the Sublease on the terms and conditions set out in, the Sublease, including the amount of rent payable.​

​