On October 17, 2012, the Supreme Court of Canada released a decision with significant consequences for real estate developers using single-purpose corporations. Such corporations are commonly created for the sole purpose of purchasing and developing a property. In Southcott Estates Inc. v. Toronto Catholic District School Board, 2012 SCC 51, the Supreme Court of Canada, by a 6-1 majority, makes it clear that if a deal goes sour, a single-purpose corporation has a duty to mitigate its losses by attempting to purchase an alternative property. If the subject property is an investment property, specific performance (i.e. requiring the vendor to sell the property) is generally inappropriate and seeking the remedy will not justify a failure to mitigate.
The parties and the deal
Southcott Estates Inc. (the "Purchaser") was a single-purpose corporation set up through the Ballantry Group of Companies ("Ballantry") to purchase and develop a property. The Purchaser had no assets except for the deposit money advanced by Ballantry. The Purchaser entered into an agreement with the Toronto Catholic District School Board (the "Vendor") to purchase a 4.78 acre surplus property for $3.44 million (the "Property"). The deal fell apart when the Vendor failed to satisfy a severance condition and refused to extend the closing date. The Purchaser sued for specific performance and, alternatively, damages, arguing that the Vendor did not use its best efforts to obtain the severance. The Purchaser admitted it had no intention to mitigate its losses by attempting to purchase an alternative property.
Single-purpose corporations have a duty to mitigate losses
The court held that a single-purpose corporation is required to mitigate its losses after a breach by making diligent efforts to find a substitute property. The court dismissed the Purchaser's argument that single-purpose corporations should be relieved from having to mitigate because of their unique nature, limited assets and lack of corporate mandate to purchase alternative properties. In the court's view, not requiring a single-purpose corporation to mitigate its losses would give an unfair advantage to those conducting business through single-purpose corporations and would expose defendants contracting with such corporations to higher damage awards. The court also noted that since the Purchaser claimed to have resources available to complete the transaction, it could have used those resources to mitigate.
The court held that expert evidence established that comparable investment properties were available and, by not pursuing those opportunities, the Purchaser failed to mitigate its losses. The evidence included 81 parcels of vacant undeveloped land and 49 properties subdivided into lots that had been sold between the date of breach and date of trial. Other subsidiaries of Ballantry had also purchased several comparable investment properties in the time since the breach by the Vendor.
Specific performance is generally not appropriate for investment properties and seeking the remedy will not justify a failure to mitigate
It is established law that specific performance is only available where money cannot fully compensate for the loss because the land has some unique, peculiar and special value. In this case, the Purchaser failed to prove that the Property was anything more than an investment opportunity. The court noted that a failure to mitigate may be reasonable if a person has a "fair, real, and substantial justification" or a "substantial and legitimate interest" in seeking specific performance. In the court's view, a person deprived of an investment property does not have such justification or interest in specific performance. Rather, money is appropriate compensation. Since the Purchaser could not justify its failure to mitigate, the court awarded only nominal damages of $1 for the breach by the Vendor.
A note about best efforts
There was no dispute that the Vendor breached the agreement by failing to use its best efforts to obtain the severance. Parties contemplating real estate transactions involving a severance condition should be aware of the kinds of factors courts will look at when considering if a party used its best efforts. In this case, the court found the Vendor failed to contact relevant city staff; delayed processing the severance application; failed to include the proposed plan of use with the severance application; submitted an improper survey; failed to seek appropriate advice; ignored the advice of the Committee of Adjustments; proceeded with the application for severance even after being advised that it was incomplete; and failed to keep the Purchaser informed.
Implications for real estate developers
Real estate developers must be aware of the approach a court is likely to take in the event a single-purpose corporation is involved in a failed purchase and sale transaction. Such corporations are not freed from the obligation to mitigate, despite a unique corporate structure, lack of assets and limited mandate.
If a developer is considering using a single-purpose corporation in a development project, appropriate measures should be taken in light of the Southcott decision. For instance, it may be appropriate at the outset of a development project to reconsider the corporate structure adopted. If a single-purpose corporation is used, it may be prudent to have a backup "mitigation plan" in place and provide the single-purpose corporation with the mandate to seek out alternative investment properties if the deal falls apart. Finally, a clearly drafted agreement of purchase and sale may allow a purchaser to obtain the remedy of specific performance in the case of an investment property, notwithstanding the default position at law outlined in Southcott.
If a breach does occur and litigation is contemplated, the decision to seek the remedy of specific performance must be made carefully in light of the facts, including the terms of the agreement of purchase and sale and whether the property is an investment property. Where a development project is likely to be characterized by a court as not unique, absent protections in the agreement of purchase and sale, specific performance is unlikely to be awarded and the purchaser will be expected to mitigate its losses.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.