Tuesday, May 10, 2016

ACCELERATED RENT OR PENALTY CLAUSE?



The distinction could be important, as was illustrated in the Superior Court decision of Riocan Holdings (Qu├ębec) Inc. v. April Canada Inc., 2014 QCCS 3967.

The Landlord (“Riocan”) and the Tenant (“April”) entered into a commercial lease in 2010 for a term of 5 years. April, however, prematurely and unilaterally cancelled the lease in June 2012 and Riocan accepted the cancellation. The dispute centered on what indemnity Riocan could claim from April in the circumstances.

The lease included a clause that allowed Riocan, in the event of cancellation of the lease, to immediately claim the equivalent of the current month’s rent and that of the next 6 months, under reserve of all other rights of the landlord, including the right to claim additional damages (underlined by the author).

Riocan eventually found a new tenant with whom it negotiated a new lease commencing in March 2013 for less rent than what April paid and which also provided for a lease inducement of 4 months free rent.

Riocan claimed that its actual damages exceeded the equivalent of 6 months’ rent which only compensated it until the end of December 2012. It also claimed for lost rent from January 2013 to September 2013 (when the new tenant began paying the rent) as well as the shortfall between the lower amount of the new rent and the rent that April paid (a difference of $922.63 per month) until the end of the original lease in September 2015.

The Trial Judge found that April did not have to pay damages for Riocan’s lost rent over and above the 6-month period provided for in the lease. He reasoned was that the clause in question was a penalty clause as defined by Articles 1622 and 1623 of the Civil Code of Quebec. The purpose of such a clause is to evaluate in advance, the damages that the landlord would incur from the tenant’s default, thereby making it unnecessary to prove either the existence or the amount of actual damages. The downside for the landlord is that a penalty clause limits the landlord’s right to the amount established by the penalty clause, even if the actual damages incurred turn out to be much greater.

Instead of requiring the tenant the pay the equivalent of 6 months’ rent in the event of cancellation of the lease, the clause could have provided that in the event of tenant’s default, rent for the current month and the next six months would become immediately due and owing and, at the option of the landlord, it could cancel the lease under reserve of all other available remedies and recourses.

The dilemma for Riocan was that, in addition to the unfavourable drafting of the clause, Riocan asked for the cancellation of the lease as a remedy, which triggered the application of the penalty clause. Alternatively, Riocan could have asked the Court to order April to respect the lease, i.e. to pay the rent at least until another tenant could be found to occupy the premises. Claiming rent instead of its equivalent in damages could have avoided the application of the penalty clause. The remedy of specific performance in such circumstances however, would be subject to the discretion of the Court and not at all clear cut.

It is common for commercial leases to have an acceleration of rent clause in the event of tenant’s default. It is advisable to ensure that such clauses are not drafted so as to be interpreted as penalty clauses that preclude the landlord’s right to claim additional damages.

In the present case, the Court stated that the penalty clause would not necessarily preclude Riocan from claiming the shortfall of rent paid by the new tenant. However, the Court was of the opinion that Riocan was not diligent in deploying reasonable efforts to mitigate its damages by finding a new tenant to replace April. According to the evidence retained by the Court, Riocan was excessively passive for a period of 6 months after the cancellation of April’s lease when it should have made reasonable efforts to find a new tenant. Furthermore, the Court was of the opinion that, had Riocan been more proactive, it likely would have found a tenant sooner, who would not have paid less rent than April did. Moreover, had Riocan been more diligent, the Court found that Riocan likely could have avoided granting a rent inducement to a new tenant.

In conclusion, the Court only granted Riocan the unpaid balance of the 6-month indemnity provided for in the lease, plus interest, and an additional amount equivalent to 15% thereof as an indemnity for legal expenses which was provided for in the lease.