Ontario Court of Appeal dusts off section 3 of the Commercial Tenancies Act

The Ontario Court of Appeal recently interpreted a provision of the Commercial Tenancies Act (Ontario) (the CTA) that had been sitting in “dusty obscurity” and scholars had described as “curious” and “mysterious.” The court clarified that section 3 of the CTA provides parties with some relief from the strict application of the common law rule requiring a reservation of the term’s final day to create a sublease.

Facts

In V Hazelton Limited v Perfect Smile Dental Inc.,¹ a tenant entered into a lease with a landlord, which lease contained an option to renew. The tenant later subleased the premises to a third party, but did not reserve the last day of the term to itself. The purported sublease did, however, expressly exclude the tenant’s renewal option.

At the end of the term, the head tenant attempted to exercise the renewal option, but the landlord maintained that the failure to reserve the last day resulted in an assignment of the lease to the third party, with the resulting effect that the head tenant could no longer exercise the option. The head tenant therefore commenced an application seeking a declaration that it had rightfully exercised its option to renew the lease.

Conflicting case law

At first instance, the application judge noted an apparent conflict in the case law on assignments and subleases. On one hand, courts had generally found that a sublease of an entire term operates as an assignment due to the lack of a reversionary interest in the original tenant, a necessary component of the landlord-tenant relationship at common law. According to the Court of Appeal, this approach is strongly rooted in case law and reflected in the common practice of reserving the last day of the term from a sublease.

However, another line of cases from Alberta, Nova Scotia, and the United States has recently emerged that broadened the notion of a reversionary interest beyond the temporal restriction. In these cases, courts have found a reversionary interest even where the term’s last day is not reserved so long as the rights otherwise granted are more restrictive than those contained in the head lease.

Section 3 of the Commercial Tenancies Act

The Court of Appeal noted the application judge failed to resolve this apparent conflict, but neither party had drawn his attention to section 3 of the CTA. Despite having been enacted in 1895, section 3 largely went unreferenced in the case law. In fact, the court quoted scholars that referred to the provision as sitting “in dusty obscurity” despite it “thumb[ing] its nose at several centuries of accumulated law.”

According to section 3, “A reversion in the lessor is not necessary in order to create the relation of landlord and tenant.” The court interpreted this passage to mean there may be a sublease even if the last day of the term is not reserved, provided there is sufficient evidence to show that the objective intention of the parties was not to create an assignment.

In this case, the fact the sublease made plain that the head tenant had a right to renew but was not obligated to renew on behalf of the third party was evidence that the parties did not intend to create an assignment. The court therefore found that the transaction was in fact a sublease and granted the head tenant the relief sought.

Practical impact

While the court’s decision relaxes the rule that the last day of the term must be reserved to create a sublease, practitioners are unlikely to begin relying upon this relaxation and are much more likely to continue reserving the last day. It should also be noted the impact of this case is limited to leases governed by Ontario law, as the provision in question is unique to Ontario.

Professionals in the commercial leasing industry may want to continue to monitor decisions dealing with section 3. The court’s decision in this instance is limited to one aspect of that provision, but another equally “mysterious” portion of section 3 remains unclarified by the court – that portion states the “relation of landlord and tenant does not depend on tenure.” The potential impact of this wording on the relationship between landlord and tenant at common law therefore remains to be seen.