Don’t open yourself up to claims when open-air space forms part of your leased premises

In Pinnacle International (One Yonge) Ltd. v. Torstar Corporation, 2024 ONCA 755, the Ontario Court of Appeal addressed several issues of broad importance relating to contractual rights in lease and sublease agreements. The Court clarified the extent to which the factual matrix should be taken into account when examining leases and subleases, the importance of defining key terms when drafting contracts, and the applicability of the Limitations Act and Real Property Limitations Act.

What you need to know

• Clarity in drafting: In contracts, it is crucial to include provisions defining key terms and concepts with precision in order to avoid ambiguity and subsequent disagreement regarding their meaning—in this case, those terms being “profit” and “reasonable costs”. As is often the case in commercial real estate leases, there is a negotiation between landlords and tenants in terms of who is entitled to profits received from a subtenant’s rent over and above the amount of rent payable by the tenant to the landlord. As this ruling has illustrated, it is essential that the parties be crystal clear in the lease as to which party is to benefit from these profits, at what time (i.e., throughout the entire term, including or excluding applicable fixturing periods, etc.) and as to which inclusions and exclusions form the calculation of net profits, including which portion(s) of the leased premises will be included or excluded. The parties should also consider having a dispute resolution mechanism for resolving any disputes between the parties as it relates to the calculation of such net profits.
• The factual matrix always matters: The majority affirmed that for leases (like other commercial contracts), courts must examine the factual background known by the parties at the point a contract is formed. This approach should be distinguished from a purely textual analysis, ensuring that contractual interpretation is anchored, to some degree, in the actual circumstances surrounding the contract’s drafting and execution.
• Applicable limitation period: Payments flowing from a lease that are not strictly considered to be “rent”, even if the contract defines the payments as such, may be governed by the two-year limitation period under the Limitations Act, as opposed to the six-year limitation period under the Real Property Limitations Act. Said differently, just because the parties classify a payment owing under a lease or sublease as “rent” (and therefore seek to enforce the payment of arrears of “rent”) does not necessarily mean that the court will agree with the parties classification of such payment(s) as being on account of “rent” and, as such, there is a risk that the shorter two-year limitation period will govern.

The details

Background

Torstar Corporation occupied the commercial building at 1 Yonge Street from 1971 to 2022. Torstar, the tenant, was required under its commercial lease with Pinnacle International (One Yonge) Ltd., the landlord, to pay Pinnacle net “profit” earned from any sublease. The question at issue in this case is what constituted this “profit”.

The building consists of two connected sections: (1) a 25-storey office tower and (2) a six-storey “Podium”, including a three-storey open-space warehouse.

At the heart of this appeal was the warehouse’s third storey. The floorplan showed the warehouse to consist of (1) the third floor of the office tower (46,707 sq. ft.) and (2) the third-floor open-air space of the warehouse (18,827 sq. ft.). Accordingly, the lease set out the total third-floor rentable area of the building as 65,534 sq. ft. The warehouse has no second- or third-storey floors—there is open-air space from the ground floor up to the ceiling.

Article 8.1 of the lease stated that Torstar was allowed to sublet the leased space. However, any profit made by Torstar from subletting must—after deducting all “reasonable costs” associated with it—be passed on to Pinnacle as additional rent.

On July 1, 2011, Torstar and College Boreal entered into a sublease terminating on August 30, 2020.

While the lease provided that the leased “Rentable Area” on the third floor consisted of 65,534 sq. ft., according to the sublease, the sublet premises included the entire third floor of the building and comprised an area of approximately 46,707 sq. ft. The sublease referred to this area as the “Deemed Rentable Area”.

Significantly, for the full term of the sublease, neither Torstar nor Boreal had access to nor use of the third-floor open-air space.

At all times, the aggregate rent paid by Torstar to Pinnacle for the entire third floor had been greater than the aggregate rent received by Torstar from Boreal. In fact, Torstar incurred a $2.6 million loss on the sublet premises.

Nevertheless, Pinnacle alleged that Torstar profited from the sublease. The motion judge, held in Pinnacle’s favour, requiring Torstar to pay Pinnacle $1.1 million. For the motion judge, article 8.1 of the lease precluded Torstar from deducting the full third-floor rent it paid to Pinnacle as a “reasonable cost” in determining whether it had profited from the sublease. The motion judge also found that the six-year limitation period in the Real Property Limitations Act applied based on the outstanding payments being arrears of rent.

Key issues

There were two key issues on appeal. The first was whether the interpretation of the sublease included incorporating the third-floor open-air space, and if so, whether it could be included as a reasonable cost deductible from profit in the lease. Second, there was the question of which limitation period applied.

The court’s decision

The majority of the Court allowed the appeal, holding in the tenant’s favour. It accepted that the third-floor open-air space was part of the sublease rented out to Boreal and should be included as a reasonable cost deductible from profit within the purpose of article 8.1 of the lease. Further, the majority found that the two-year limitation period in the Limitations Act applied (i.e. that the amounts payable were not truly arrears of “rent” to which the six-year limitation period would apply).

The motion judge’s interpretation of the Lease and Sublease

The majority opinion

In short, the majority held that it was a significant error to prevent Torstar from deducting the full rent of the entire third floor as a reasonable cost. As is discussed below, there were three major errors.

The first error related to the factual matrix. The majority emphasized the importance for all contracts, including leases, of looking beyond the bare text to the surrounding circumstances. When Torstar and Boreal entered into the sublease, everyone knew that the third-floor open-air space was under Pinnacle’s control and that neither Torstar nor Boreal could use or access it. Moreover, despite this lack of control and ability to use and access the space, Torstar was obliged to pay Pinnacle rent on the full third floor. It would not have made commercial sense for Torstar to sublet only the usable third-floor space—there was no purpose to the third-floor open-air space otherwise.

Second, the motion judge erred in not considering the sublease as a whole; when the recitals and relevant provisions are viewed in light of the factual matrix, the sublease applied to the entire third floor, with rent calculated based on the usable portion.

Third, excluding the full rent for the third floor from “reasonable costs” and the calculation of profit resulted in a commercial absurdity. Requiring Torstar to pay Pinnacle over $1.1 million for subleasing the space when Torstar incurred a $2.6 million loss on the sublet premises was not commercially reasonable. Because the lease did not define “profit”, the majority maintained that its ordinary and grammatical meaning should prevail, which is “the excess of returns over expenditure”. To adopt the motion judge’s interpretation would be to give Pinnacle a large and unintended windfall.

The dissent

The dissent disagreed with the majority’s conclusion that the sublet premises comprised the full third floor, with rent calculated based on the third floor’s usable portion. This was inconsistent with the terms of the lease and the factual matrix:

• The sublease stated that the area of the sublet premises was “deemed” to be 46,770 sq. ft. and “shall not be subject to re-adjustment”. Accordingly, the minority held that it seems plausible that laying out a rentable area “not to be subject to re-adjustment” was aimed at preventing either party from “pulling out a measuring tape post-execution” in an attempt to modify the area on which rent was payable.
• There was a representation and warranty made in the sublease that, to the best of Torstar’s knowledge and belief, the building provides for barrier-free access to the third floor, and that the subtenant’s staff shall be able to access the premises at any time. Those covenants are only comprehensible if what Boreal was subleasing was the usable office portion of the third floor. If the sublet premises were meant to include the inaccessible open-air warehouse space, the covenants would not make sense.
• It would make little sense for Torstar to provide the open-air space rent-free and for Boreal to risk being exposed to liability for it, particularly as the space was inaccessible. Upon entering into the lease, Torstar knew that the third-floor open-air space could very well become an “orphan” space that would be difficult to sublet. There is nothing absurd about Torstar having to bear the cost of the deal it struck.

In sum, payment of rent on the third-floor open-air space “that was not subleased to Boreal” cannot be seen as a cost incurred in connection with the sublease. Rather, it was an obligation flowing solely from Torstar’s lease with Pinnacle.

The Limitation Act’s application to the claim for net profit

In Ontario, limitation periods are primarily governed by two statutes: the Limitations Act and the Real Property Limitations Act. The Limitations Act provides general and default limitation periods for most claims, while the Real Property Limitations Act establishes specific limitation periods for certain real property matters.

Under the Limitations Act, the basic limitation period is two years from the day the claimant discovered, or ought to have discovered, the claim. There is also an ultimate limitation period in the statute, meaning that regardless of discoverability, no claim may be brought more than 15 years after the related act or omission occurred.

The Real Property Limitations Act outlines various limitation periods, including six years for arrears of rent or interest thereon, as well as a number of accompanying exceptions. For instance, this six-year limitation period does not apply to an action for redemption brought by a mortgagor or a person claiming under the mortgagor. A further exception includes where a prior mortgagee has been in possession of the land or receiving profits from it within a year before a subsequent mortgagee initiates legal action. In this case, the subsequent mortgagee can recover all the arrears of interest accrued during the prior mortgagee’s possession, even if it exceeds six years.

The majority held that the Limitations Act applied to the claim for net profit under article 8.1—overruling the holding of the motions judge.

The claim was “not based on an obligation to pay ‘rent’”, as that word is defined in the Real Property Limitations Act. Instead, the claim was for a breach of a term of the lease, which is governed by the Limitations Act. A two-year limitation period should therefore prevail.

Section 17(1) of the Real Property Limitations Act applies to the recovery of “arrears of rent, or of interest in respect of any sum of money charged upon or payable out of any land or rent”. And according to the majority, Torstar was obliged to pay Pinnacle net “profit”, not rent.

The application of the Limitations Act should be construed broadly as it was intended by the legislature to be “a single, comprehensive general limitations law”. Confining the analysis to whether the parties labelled the payment “rent” would undermine the legislative purpose, privileging form over substance.  

Implications

This decision provides several noteworthy insights regarding both contract drafting and interpretation. Concerning drafting, it is critical that parties carefully define key terms, such as “profit” and “reasonable costs”. Assuming that commercial reasonableness, general standard terms or commonly understood terms in the commercial real estate industry will apply is a recipe for failure. Failure to do so could entail costly disputes, as occurred between Torstar and Pinnacle. As for contractual interpretation, the Court reiterated that textual analysis is insufficient. A holistic approach, taking into account the broader factual circumstances objectively known to the parties at the time of contracting must be considered. Recitals, preambles, and surrounding commercial circumstances will be key in understanding contracts. This decision cautions landlords, tenants, and their counsel to exercise prudence in structuring arrangements, anticipating complex subleasing arrangements, and documenting the nature and scope of obligations to mitigate future risks.