Most commercial leases contain a provision that requires the tenant to obtain the landlord's consent to any “transfer” of the lease, which usually includes, within its definition, a change of control (both direct and indirect, as well as de facto and de jure). While undertaking due-diligence on behalf of a client that hopes to sell its shares and effect a change of control, it is important to carefully review the transfer provision to ensure that the consent requirements are complied with.
When reviewing commercial leases in the course of corporate due-diligence, lawyers must verify the transfer provisions and determine whether consent from the landlord is required in connection with a change of control. In light of the fact that a change of control does not result in a change of the corporate entity that has executed the lease as tenant, most well drafted commercial leases will contain explicit language stating that a change of control is considered to be an assignment of the lease, and thus subject to the transfer provisions of the lease. In these instances, if the lease requires that the tenant obtain consent before effecting a transfer and the tenant does not obtain same prior to closing, the tenant will be in breach of its lease agreement, thus enabling the landlord to exercise the “default” recourses provided for in the lease, which could potentially result in the termination of the lease.
Most transfer provisions contain a requirement that when consent to a change of control is requested, the landlord must not unreasonably withhold consent. In the absence of a reasonability requirement, Section 23 of the Commercial Tenancies Act provides that unless a lease explicitly indicates that the landlord can unreasonably withhold consent, the landlord must not do so.
What is considered “reasonable” was recently discussed by the Ontario Court of Appeal in Rabin v. 2490918 Ontario Inc. (2023 ONCA 49). The Court of Appeal applied the following factors to its analysis of reasonability:
- The burden is on the tenant to satisfy the court that the refusal to consent was unreasonable.
- It is the information available to – and the reasons given by – the landlord at the time of the refusal and not any additional, or different, facts or reasons provided subsequently to the court that is material.
- The question must be considered in the light of the existing provisions of the lease that define and delimit the subject matter of the assignment as well as the right of the tenant to assign and that of the landlord to withhold consent.
- A probability that the proposed assignee will default in its obligations under the lease may, depending upon the circumstances, be reasonable ground for withholding consent.
- The financial position of the assignee may be a relevant consideration.
- The question of reasonableness is essentially one fact that must be determined on the circumstances of the particular case, including the commercial realities of the marketplace and the economic impact of an assignment on the landlord.
When consent has been requested and denied in the course of due diligence for a corporate transaction, lawyers should use these factors to determine whether the withholding of consent was reasonable. It is important to remember that in a situation involving a change of control, the entity that is the tenant remains the same, and thus the factors to be reviewed must be considered in light of this.
These factors should also be considered when drafting a lease for a tenant who may wish to sell its business at a later date. The transfer clause, including the definition of what constitutes a transfer and the factors that the landlord takes into account in deciding whether to grant or withhold consent and whether same are determined reasonable or unreasonable, should be carefully crafted. Lawyers must ensure that, when representing a tenant, the landlord cannot withhold consent in a manner that will hold up a transaction, and when representing a landlord, the landlord's conditions would not be interpreted as being unreasonable.
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.