1. Introduction - Old Problem, New Circumstances
Commercial tenants may not understand that they can be evicted if the landlord defaults under its mortgage, even if the tenant continues to pay its rent and comply with the terms of the lease. This article will address the circumstances under which a commercial tenant could lose its lease and its right to occupy the premises to a mortgagee in Ontario and how to avoid that result. I will also review the steps that can be taken to ensure the lease will survive a mortgage default, while still retaining all of the accrued rights and remedies which have arisen prior to the mortgage default, intact and enforceable by the tenant.
COVID-19 and the resulting economic crisis have made security of tenure (the prevention of the unilateral termination of the lease and retaking of possession from the tenant) more relevant and default under mortgages more likely to occur as retail tenants struggle to reopen, commercial tenants struggle to pay rent and all tenants try to come to terms with the value proposition of maintaining physical locations for business. Landlords could face higher vacancies, declining cash flow from rents, and demands from lenders to maintain payments on mortgages taken out under different economic circumstances. The result is that some landlords will default under their mortgages.
From the tenant's perspective, security of tenure will become an issue for those who occupy commercial premises if the landlord defaults on its mortgage and the lender steps in (in this article I will refer to the lender as the "mortgagee" assuming the loan is by way of a mortgage/charge on the property). Related issues that I will address include the question of who will carry out the landlord's obligations under the lease and, if the mortgagee goes into possession of the property or sells it and the tenant remains, will the tenant be able to continue to enforce and rely on any of its accrued rights and all of the terms of its existing lease.
As a lawyer who has a great deal of experience dealing with lease negotiations, drafting and registration issues are very familiar to me. The pure title issues and real estate issues are dealt with less often by me because, as a practical matter, professionals practicing mortgage enforcement do not often involve the leasing professionals when a mortgagee enforces it mortgage. Disputes are often negotiated, the tenant and mortgagee generally come to terms as they often want the same thing - namely, the tenant to stay. The installation of a receiver by the mortgagee or the court to manage the property and facilitate the foreclosure or sale process also avoids many of the pitfalls which are described in the Goodyear case and other cases cited herein. There are many good articles addressing the finer real estate issues.
I am going to assume for the purposes of this paper that the registered owner of the property has granted a mortgage to a lender and has also entered into a lease of some or all of the property. If the lease is with a head tenant, as landlord, there may be additional considerations not dealt with in this article. This article does not address residential leases.
2. Right of the Landlord or the Tenant to Terminate the Lease
A commercial lease represents an interest in the property - a "leasehold interest". As a result, it is governed by the system of registrations and the rules of priority under the Land Titles Act (Ontario) or the Registry Act (Ontario). The general rule is that the priority of interests in the property are determined by order of registration.
When an owner acquires a property, it registers its deed. The owner (who will be our "landlord") owns all of the property rights, the "freehold interest", subject to existing easements and agreements and certain exceptions which I will address later. The freehold interest is superior to a leasehold interest in the property. The landlord then takes out a loan from a mortgagee and grants a charge1 on its freehold interest in favour of the mortgagee. The landlord may also be asked to give additional security by way of an assignment of rents and an assignment of leases. The mortgagee registers its mortgage on title and may also make registrations for its assignment of rents and assignment of leases. When a landlord enters into a lease with a commercial tenant the tenant can register that lease on title. If we were to get a copy of the parcel register from the land titles office for this property after the foregoing, we would see the following documents registered on title in the following order:
- The Deed;
- The Mortgage (and possibly assignment of rents and PPSA notice); and
- The Notice of lease (or the lease or a short form of lease). 2
The way the law of property in Ontario works is that the owner can grant rights to a mortgagee and the tenant and its interest is then subject to the rights of the mortgagee and the tenant. The mortgagee and the tenant can then enforce their mortgage and lease, respectively, against the landlord.
Things get more complicated when it comes to the mortgagee enforcing its mortgage rights against the tenant and the tenant enforcing its rights under the lease against the mortgagee. This becomes an issue when the landlord defaults under the mortgage and the mortgagee pursues its remedies under the mortgage, the assignment of rents and/or an assignment of leases.
The remedies the mortgagee may pursue against the landlord and the property include:
- seeking to enter into possession of the property itself or through a receiver; and
- foreclosing and becoming registered owner of the property; or
- selling the property under power of sale to a third party.
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1. Section 1 of the Land Registration Reform Act, R.S.O (1990) c. L.4 defines a charge as "a charge on land given for the purpose of securing the payment of a debt or the performance of an obligation, and includes a charge under the Land Titles Act and a mortgage, but does not include a rent charge; ("charge")"
2. Land Titles Act, R.S.O. 1990, c. L.5, s. 38; Registry Act, R.S.O. 1990, c. R.20, s. 22(7). Provisions regarding what can be registered in respect of a lease.
Originally Published by Law Society of Ontario.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be ought about your specific circumstances.