V Hazelton Limited v. Perfect Smile Dental Inc., 2019 ONCA 423

COURT OF APPEAL FOR ONTARIO

CITATION: V Hazelton Limited v. Perfect Smile Dental Inc., 2019 ONCA 423

DATE: 20190523

DOCKET: C65696

Watt, Hourigan and Huscroft JJ.A.

BETWEEN

V Hazelton Limited

Applicant (Appellant)

and

Perfect Smile Dental Inc., Outhere by Marcus Chaves Corp.,

Outhere by Marcus Chavez and Marcus Chaves

Respondents (Respondents)

Heard: March 15, 2019

On appeal from the judgment of Justice Edward M. Morgan of the Superior Court of Justice, dated June 22, 2018, with reasons reported at 2018 ONSC 3958 (CanLII).

Hourigan J.A.:

Part I: Overview

[1]         This appeal engages fundamental issues regarding the nature and operation of commercial tenancies and in particular the impact of a sublease on the relationship between landlord and tenant. It arises from a situation where the appellant, V Hazelton Ltd. (“Hazelton”), leased commercial premises from the respondent, Perfect Smile Dental Inc. (“Perfect Smile”). Pursuant to the lease, Hazelton had a right to renew for an additional five years on the expiry of the initial seven-year term. Hazelton proceeded to sublet the premises to a third party but did not reserve the last day of the head lease term to itself.

[2]         Hazelton attempted to exercise the option to renew the lease, but Perfect Smile maintained that it no longer had that option. On an application for relief brought by Hazelton, the principal issue to be decided was whether, by reason of its failure to reserve the last day of the head lease term, Hazelton had in effect made an assignment and forfeited its leasehold rights. The application judge failed to provide an answer to that question. Instead, he ruled that Hazelton had a claim for breach of contract against Perfect Smile, but that it had suffered no damages. He therefore dismissed the application.

[3]         In these reasons, after a brief factual review and a consideration of the decision below, I analyze the nature of commercial tenancies, the effect of Hazelton’s failure to reserve the last day of the head lease, whether Hazelton breached the lease, and whether the application judge erred in his analysis of damages. Ultimately, I conclude that the appeal must be allowed and an order should go permitting Hazelton to renew the lease and providing other related relief.

Part II: Facts

[4]         Hazelton operated a retail clothing business at Hazelton Lanes in Toronto. Perfect Smile owns the premises at issue, which are located on Bay Street, as well as a dental practice nearby.

[5]         In September 2010, Hazelton entered into an agreement with Perfect Smile to lease the premises. The initial term of the agreement was seven years, commencing October 1, 2010 and expiring September 30, 2017. There was also a five-year renewal option for Hazelton in s. 9 of the agreement. Perfect Smile and Hazelton entered into a formal lease on October 1, 2012. The option to renew became s. 7 of the lease, which provides:

OPTION TO RENEW

Provided the Tenant is not in default under the lease as to the time of the notice and provided the Tenant gives the Landlord six (6) months prior written notice, the Tenant shall be given the option to renew for an additional term of Five (5) years on the same terms and conditions, save for any further options to renew and save and except for rent which will be mutually agreed upon by the Tenant and Landlord, both acting reasonably, failing which this option to renew shall go to arbitrationunder the Arbitration Act of Ontario.

[6]         Hazelton completed substantial renovation work on the premises, including the removal of a bathroom. Whether the removal of the bathroom was undertaken with the consent of Perfect Smile remains an issue between the parties. Hazelton contends that the renovations concluded in 2013 and that the total cost was about $280,000. Further, it says that it obtained a loan for the work, of which $70,000 remains owing, and submits that it would not have spent money to renovate without the benefit of the seven-year term and the additional five-year renewal term.

[7]         In August 2016, with Perfect Smile’s consent, Hazelton entered into a sublease with a retail clothing store called Outhere by Marcus Chaves (“Outhere”), operated by the respondent Marcus Chaves. The term of the sublease was from September 1, 2016 to September 30, 2017. The sublease did not reserve the last day of the head lease’s term to Hazelton; instead, the head lease and the sublease were set to expire on the same day.

[8]         In the sublease agreement, Hazelton expressly exempted and excluded the five-year renewal term, per section C of Schedule “A”, which reads as follows:

Sub-lease: notwithstanding that the head Lease contains a provision allowing the Tenant to renew the Lease for a further term as set out therein, there is no obligation by the Sub-Landlord to renew in favour of the Sub-Tenant and the Sub-Tenant acknowledges that they have no such right of renewal or extension of the Lease. The Sub-Lease is only for the term set out herein.

[9]         On March 2, 2017, Hazelton purported to exercise its right to renew the lease for a further five-year term. Hazelton and Perfect Smile began negotiating rent through email exchanges but could not agree on a new rental rate.

[10]      On September 28, 2017, counsel for Perfect Smile delivered a letter to Hazelton stating it had no right to exercise the five-year renewal option. The lease expired on September 30, 2017. Pursuant to an arrangement with Perfect Smile, Outhere remained in possession of the premises after the sublease ended. Outhere paid Perfect Smile the same rent it had previously paid under the sublease.

[11]      Hazelton commenced an application seeking various heads of relief, including:

  •                 A declaration that it had rightfully exercised its option to a five-year renewal of its lease starting October 1, 2017;
  •                 An order that Perfect Smile and Outhere deliver vacant possession of the premises; and
  •                 An order that, in accordance with the terms of the lease, an arbitrator be appointed to determine the rent payable during the five-year renewal period.

Part III: Decision of the Application Judge

[12]      The application judge began his analysis by finding that Perfect Smile had initially accepted Hazelton’s exercise of its renewal option under the lease and that it understood arbitration was the mandated manner under the lease to resolve an impasse over the new rental rate. He also found that Hazelton was not in default under the lease because Perfect Smile had never given Hazelton notice of the alleged default with respect to removal of the bathroom, despite knowing about the renovations by at least early 2017.

[13]      The application judge then stated that, generally speaking, where rights granted in a sublease are more restrictive than those contained in a head lease, the result is that the rights not granted to the subtenant are reserved to the tenant. In support of that proposition, he relied on Letourneau Developments v. Red Fort Realty Ltd. (1985), 1985 ABCA 201 (CanLII), 40 Alta. L.R. (2d) 397 (C.A.), at p. 398. He found that this general principle applied in this case, as Hazelton had specifically reserved the renewal option in the sublease.

[14]      The application judge then commented that Perfect Smile relied on “ancient common law” for the proposition that where a tenant has sublet the tenancy but has not reserved the last day of the head lease term for itself, the sublease is deemed to be an assignment. He cited, among other cases, Selby v. Robinson (1865), 15 U.C.C.P. 370.

[15]      The application judge did not resolve the apparent conflict in the case law. Instead, he noted that while counsel for Perfect Smile “may well be correct in his analysis of the estate aspect of a commercial Lease”, there was also a contractual element to a commercial lease. He found that Perfect Smile breached its contractual duty of good faith, as enunciated in Bhasin v. Hrynew, 2014 SCC 71 (CanLII), [2014] 3 SCR 494, by failing to negotiate or arbitrate the renewal in good faith.

[16]      According to the application judge, Hazelton could claim damages as a consequence of this contractual breach. However, the application judge found that Hazelton had not suffered any loss. He acknowledged that Hazleton could have sublet the premises again but considered it unclear whether the sublet would have been profitable because the rent was unknown. The application judge presumed, based on the circumstances of the case, that the current rent paid by Outhere reflected fair market value. Thus, Hazelton would have at best only broken even.

[17]      With respect to Mr. Chaves, the application judge concluded that he also breached a duty of good faith owed to Hazelton, as he knew about Hazelton’s renewal option but deliberately engaged in conduct that undermined its rights. However, the application judge concluded that the breach caused no economic loss. Since Mr. Chaves had provided a $10,000 deposit to Hazelton, the application judge ordered that it should be returned to Mr. Chaves.

[18]      No party drew to the application judge’s attention s. 3 of the Commercial Tenancies Act, R.S.O. 1990, c. L. 7 (the “CTA”), which is key to the disposition of this appeal.

[19]      The application judge did not award costs because there was mixed success on the application.

Part IV: Analysis

(i)           Jurisdiction of this Court

[20]      Perfect Smile raised a threshold issue about this court’s jurisdiction to hear the appeal. It submitted that where a judge grants or refuses a writ of possession over leased premises, any appeal lies to the Divisional Court, pursuant to s. 78 (1) of the CTA, which provides:

  1. (1) An appeal lies to the Divisional Court from the order of the judge granting or refusing a writ of possession.

[21]      During oral argument this jurisdictional objection was dismissed with reasons to follow. It may be dealt with summarily.

[22]      The application judge refused an order for delivery of vacant possession, which is arguably captured by this section. However, he also refused declaratory relief and declined to order that an arbitrator be appointed. These aspects of the decision are beyond the ambit of s. 78.

[23]      Pursuant to s. 6(2) of the Courts of Justice Act, R.S.O. 1990, c. C. 43, this court retains the discretion to combine and hear all the issues raised on this appeal. I would exercise that discretion, given the interconnected nature of the issues and the resultant risk of inconsistent judgments.

(ii)         Right of Renewal

[24]      I start from the premise that the application judge was obliged to resolve the apparent discrepancy between the lines of authority relied on by the parties. One line of cases suggests that a sublessor must reserve the last day of the term of the head lease in the sublease. The other stands for the proposition that where the rights granted in a sublease are more restricted than those contained in the head lease, the rights not granted are reserved to the sublessor. That tension was the principal issue raised on the application.

[25]      Further, as will be discussed in more detail below, Hazelton was not seeking to enforce its contractual rights to sue for damages. Rather, it was attempting to take possession of the leased premises. Thus, the application judge had to resolve the issue argued before him, because resort to Hazelton’s contractual rights to damages could not result in obtaining the relief sought.

[26]      In this section of my reasons, I will consider: the nature of a commercial lease, the common law rule regarding the failure to reserve the last day of a sublease, case law that has expanded the notion of a reversionary interest, s. 3 of the CTA, and how s. 3 impacts the common law. I will then apply the legal principles to the facts of this case.

(a)         Nature of a Commercial Lease

[27]      Professor Anne Warner La Forest describes the nature of a landlord and tenant relationship at common law and some of the relevant terminology in Anger & Honsberger Law of Real Property, vol. 1, 3d ed. loose-leaf (consulted on 7 May, 2019) (Toronto: Canada Law Book, 2006) at §7:10:

The relationship of landlord and tenant is an interest in land created by a contract, express or implied, by which one person who is possessed of an interest in real property, and who is called the “landlord” or “lessor”, confers on another person, called the “tenant” or “lessee”, the right to exclusive possession of the real property or some part of it for a period of time which is definite or can be made definite by either party, usually in consideration for a periodic payment of “rent” in either money or its equivalent. The interest in the property remaining in the landlord, being the interest which is not disposed, is called the “reversion”. The interest or estate which the tenant has in the land is known as the “term”. [Citations omitted; emphasis added.]

[28]      At common law, a lease has long been viewed as creating a property relationship between the lessor and lessee once the lessee goes into possession. A lease does not simply create a licence to occupy property; rather, it conveys a legal interest in the property: Jason Brock & Jim Phillips, “The Commercial Lease: Property or Contract?” (2001), 38 Alta. L. Rev. 989, at p. 990.

[29]      Despite the property origins of leases, it is important to understand that a commercial lease also has contractual elements. The leading case on the dual nature of a commercial lease is the judgment of Justice Bora Laskin in Highway Properties Ltd. v. Kelly, Douglas and Co. Ltd., 1971 CanLII 123 (SCC), [1971] S.C.R. 562. Justice Laskin considered the issue of the availability of contractual remedies in a commercial lease. He took a practical approach to the issue, finding it “no longer sensible to pretend that a commercial lease … is simply a conveyance and not also a contract”: Highway Properties, at p. 576.

(b)         Assignment

[30]       In this part of my reasons, I will consider the impact of failing to reserve the last day of a head lease term on a sublessor’s property rights under the head lease.

[31]      Critical to the analysis in this case is the distinction between an assignment of a lease and a sublease. When a lease is assigned to a third party, the third-party assignee becomes the tenant of the landlord and a privity of estate is established between the two. When the lease is assigned, the landlord’s privity of estate with the original tenant comes to an end, but the privity of contract remains: Crystalline Investments Ltd. v. Domgroup Ltd., 2004 SCC 3 (CanLII), [2004] 1 S.C.R. 60, at para. 29. In contrast, a sublease creates no direct relationship between the subtenant and the landlord – there is neither privity of estate nor privity of contract between them. Rather, the head tenant stands in the position of landlord vis-à-vis the subtenant, while retaining its position as tenant vis-à-vis the original landlord.

[32]      There is a long line of case law dating back hundreds of years that holds that a sublease of the entire term of the head lease operates as an assignment because there is no reversionary interest in the original tenant to support a tenurial relationship: see, for e.g., Hicks v. Downing (alias Smith v. Baker) (1696), 1 Ld. Raym. 99, 91 E.R. 962Selby; Jameson v. London and Canadian Loan and Agency Co. (1897), 1897 CanLII 4 (SCC), 27 S.C.R. 435; and Mount Citadel Ltd. v. Ibar Developments Ltd. (1976), 1976 CanLII 770 (ON SC), 73 D.L.R. (3d) 584 (Ont. H.C.). Thus, as a matter of law, the head lease is assigned unless the sublessor retains a reversionary interest by reserving for itself the last day or some other time period at the end of the term. This was the line of the authority relied on by Perfect Smile on the application.

[33]      In a seminal article on leasehold interests, Professor Ralph Scane summarized the common law’s view of leasehold interests: “The Relationship of Landlord and Tenant” in Special Lectures of the Law Society of Upper Canada 1965: The Lease in Modern Business (Toronto: Richard De Boo Ltd., 1965). He described the common law position as follows, at p. 3:

The common law’s view of a non-freehold estate, or a leasehold estate, is that it is a grant of exclusive possession of land for a determinate period of time, which is an interest less in quantity than the grantor himself possesses. The definition requires a determinate period of time because if the estate granted is limited to last for an uncertain period of time, you would be granting an estate of freehold. Also, at common law, the estate granted by the landlord must be a lesser estate than the landlord himself has. In other words, there must be a reversion in the landlord if, at common law, there is to be a landlord-tenant relationship. The landlord’s estate can be either freehold or leasehold, so long as it is greater than the estate granted to the tenant.

[34]      Current practice and more recent case law are consistent with this “ancient” common law. For example, in Sussex Square Apartments v. R.[1999] 2 C.T.C. 2143, (Tax. Ct.), at para. 31, aff’d 2000 CanLII 16119 (FCA), [2000] 4 C.T.C. 203 (F.C.A.), the court noted, “It is trite law that there is a fundamental legal difference between an assignment of a lease, where the assignor retains no reversion, and a sublease where the lessee sublets a portion of the term to a sublessee and retains a reversionary interest”. Similar comments were made by this court in Goldman v. 682980 Ontario Ltd. (2002), 2002 CanLII 20987 (ON CA), 62 O.R. (3d) 21 (C.A.), where the court noted, at para. 3, that “the leasehold interest must be supported by privity of estate and thus the assignor must reserve the last day in order to preserve the original landlord tenant relationship.” (See also Dental Co. of Canada v. Sperry Canada Ltd., 1971 CanLII 7 (SCC), [1971] S.C.R. 266; Canada Safeway Ltd. v. Surrey (City), 2004 BCCA 499 (CanLII), 35 B.C.L.R. (4th) 73, leave to appeal refused [2004] S.C.C.A. No. 577; Bengro Holdings Inc. v. Tax to Go Inc. (1996), 7 O.T.C. 283 (Gen. Div.); andDamack Holdings Ltd. v. Saanich Peninsula Savings Credit Union (1982), 19 B.L.R. 46 (B.C. S.C.).)

[35]       Consistent with this well established view, an experienced commercial leasing lawyer in Ontario, writing on the topic of assignments and subleases, has said that he could not recall any transfer in which he had been involved that was for the balance of the term that was not intended to be a full assignment: Darrell M. Gold, “Assignment v. Sublease – Reserving the Last Day” in The Six-Minute Commercial Leasing Lawyer 2008(Toronto: Law Society of Upper Canada, 2008), at pp. 22-7.

(c)         Alternative Approach

[36]      Notwithstanding the foregoing, cases from other jurisdictions demonstrate that some courts have interpreted the notion of a reversionary interest more expansively. In these cases, courts have found that there was a reversionary interest even where the last day was not reserved.

[37]      Letourneau was such a case and, as noted above, it was cited by Hazelton to the application judge. In Letourneau, the tenant sublet the premises to a third party for the balance of the term of the lease but with a more limited option to renew than that contained in the head lease. In brief reasons, the Court of Appeal agreed with the trial judge that the sublease did not amount to an assignment. At p. 398, Belzil J.A. stated:

It is evident from the fact that the trial judge awarded judgment against the original lessee Red Fort that he did not consider the sublease to be an assignment of the lease, and indeed in that he was correct because the option to renew was more restricted in the sublease than that contained in the head lease and it could not be said that the sublessor had assigned its full reversionary interest. The appellant did not argue that the lease had been fully assigned.

…It is clear that the sublessor remained tenant under the head lease and no privity between the sublessee and the appellant as head lessor was created by the sublease.

[38]      This case suggests that a tenant’s “full reversionary interest” is not assigned even where premises are sublet for the balance of the term of the lease, where the sublease provides for a more restricted option to renew than the head lease.

[39]      Another Alberta case has similarly applied a broad notion of a “reversionary interest”: Anthem Heritage Hill Ltd. v. Just One Stop Ltd.: 2006 ABQB 113 (CanLII), 389 A.R. 1, aff’d 2006 ABCA 72 (CanLII), 384 A.R. 231. The case involved a lease between Anthem, the landlord, and Crafter’s Marketplace, the head tenant. Crafter’s retained a portion of the premises and sublet a portion to Just One Stop Ltd. The issue was whether Just One Stop had a right to renew the sublease.

[40]      The head lease contained a renewal option. The sublease also included a renewal option. However, the sublease expressly noted that if Crafter’s elected not to exercise the renewal option, the sublease would terminate on the lease expiry date.

[41]      Crafter’s surrendered the lease to Anthem before the lease expired. Just One Stop tried to renew the lease, but Anthem sought a declaration that the subtenant could not do so because renewal was contingent on Crafter’s renewal of the head lease. Just One Stop argued that the sublease was an assignment because Crafter’s did not retain a reversionary interest in the head lease, as it failed to reserve the last day of the head lease’s term. It further argued that it had the same right to renew as Crafter’s under the head lease, albeit in respect of the sublet premises only.

[42]      The application judge agreed that on the grant of a sublease the sublessor must retain a reversion (i.e., an interest in the lease). Rooke J. noted that “[a]lmost without exception, the authorities define the requisite reversionary interest as a term-related one”: Anthem, at para. 26. He also noted that “the last day of the term of a headlease is an undoubted, and perhaps the most common, term-related reversionary interest”, but added that there were others: at para. 26. He was satisfied that Crafter’s had retained a reversionary interest in the head lease based on the language of the renewal option in the sublease. At para. 27, Rooke J. explained:

Just One’s right to renew the sublease was not absolute but expressly contingent on Crafter’s Marketplace’s renewal of the Headlease. Thus, while, on the grant of the Sublease, Crafter’s Marketplace did not retain a reversionary interest in the nature of the last day of the term of the Headlease, Crafter’s Marketplace did retain a term-related reversionary interest in the Headlease in order to preserve the relationship between itself and Anthem under the Headlease in respect of the Sublease premises, that being its right to renew the Headlease.

[43]      Anthem’s application was granted. The Alberta Court of Appeal dismissed an appeal from Rooke J.’s decision but did not deal with the question of whether there was a sublease or an assignment because Just One Stop abandoned its argument that the sublease was an assignment.

[44]      Similarly, Chater v. Elia, 1998 CanLII 2123 (NS CA), 1998 NSCA 39, 167 N.S.R. (2d) 166, involved a lease between the landlord and the tenant, Mr. Al-Farkh. Mr. Al-Farkh, in turn, entered into a sublease with Ms. Elia. It was argued that the subtenancy was really an assignment because Mr. Al-Farkh did not retain a reversionary interest in the premises. Cromwell J.A. rejected this argument at para. 14:

In my opinion, Elia’s submission on this point cannot succeed. As I understand the principle involved, it is this: if a tenant gives up his or her whole interest under a head lease by a purported subtenancy, the transaction is in law an assignment. In other words, there can be no sublease when there remains no tenancy to which the undertenancy is subordinated. In this case, the subtenancy related only to a portion of the premises demised under the head lease. Thus, the tenant did not, and did not intend, to give over to the “subtenant” his whole interest under the head lease. Therefore, there was in law no assignment: see Mount Citadel Ltd. v. Ibar Developments (1976), 1976 CanLII 770 (ON SC), 73 D.L.R. (3d) 584 (Ont. H. Ct.) at 589. I conclude therefore that prior to Al-Farkh’s bankruptcy, there was, as the trial judge held, a subtenancy between Al-Farkh and Elia to which the landlord consented.

[45]      These three cases from other provinces, which are outliers in Canadian law, broaden the notion of a reversionary interest beyond temporal reservations.

[46]      Some U.S. courts have also taken a more flexible view of what amounts to a reversionary interest. Andrew R. Berman, writing in Friedman on Leases, 6th ed. vol. 1 (New York: Practising Law Institute, 2017) explains the split in U.S. law, at pp. 7-92 – 7-93:

If a tenant sublets for the balance of his term there is, a priori, no intervening time between the scheduled expiration of the prime lease and that of the sublease. If a reservation is to be found, it must be of something other than time. Courts have seized on a tenant’s right of reentry for breach by the subtenant, or of a rent or of covenants that differ from those in the prime lease, or a combination of these items. Some cases have held that a subtenant’s covenant to surrender possession on the last day of the term of the prime lease leaves a “fragmentary” reversion. These have not escaped the obvious criticism that the coterminous periods permit a simultaneous expiration with no temporal gap. There is a split of American authority on what constitutes a reversion for the purpose of making a transaction a sublease rather an assignment. This might suggest the existence of some clear distinctions. Instead, there is an inconsistent and bewildering group of cases seizing upon some item as, or as not, a reversionary interest, and with little consistency within at least several states. [Citations omitted.]

[47]      As Professor Berman indicates, the desire to stretch the bounds of the common law in some states has given rise to “inconsistent and bewildering” case law. Other states still apply the traditional common law approach and the practice for creating a sublease in those states is to make sure the term expires at least one full day before the stated expiration of the prime or head lease: at p. 7-96.

[48]      These cases reflect an effort by some courts to avoid characterizing a putative sublease as an assignment by expanding the notion of a revisionary interest beyond temporal limits. Arguably, such judicial efforts are unnecessary in Ontario by reason of s. 3 of the CTA. I turn next to a consideration of that section.

(d)         Section 3 of the CTA

[49]      Neither party referred the application judge to of s. 3 of the CTA, which provides:

  1. The relation of landlord and tenant does not depend on tenure, and a reversion in the lessor is not necessary in order to create the relation of landlord and tenant, or to make applicable the incidents by law belonging to that relation; nor is it necessary, in order to give a landlord the right of distress, that there is an agreement for that purpose between the parties.

[50]      On its face, s. 3 stipulates four “negatives”:

(1)  The relation of landlord and tenant does not depend on tenure;

(2)  A reversion in the lessor is not necessary in order to create the relation of landlord and tenant;

(3)  A reversion in the lessor is not necessary in order to make applicable the incidents by law belonging to the landlord-tenant relation; and

(4)  An agreement is not necessary in order to give a landlord a right of distress.

[51]      This provision has been part of Ontario law in some form since 1895: Ontario Law Reform Commission, Report on Landlord and Tenant Law(Toronto: Ministry of the Attorney General, 1976), at p. 5; An Act respecting the relations of Landlord and Tenant, (1895) 58 Vic. c. 26, s. 4. When first introduced, it read as follows:

The relation of landlord and tenant shall be deemed to be founded in the express or implied contract of the parties, and not upon tenure or service, and a reversion shall not be necessary to such relation, which shall be deemed to subsist in all cases where there shall be an agreement to hold land from or under another in consideration of any rent. And nothing in this Act shall affect any pending litigation.

[52]      A year after the relevant provision was first introduced, it was amended: An Act respecting the Law of Landlord and Tenant, (1869) 59 Vic. c. 42, s. 3. The new section read as follows:

(1) The relation of landlord and tenant is not hereafter to depend on tenure, and a reversion or remainder in the lessor shall not be necessary in order to create the relation of landlord and tenant; or to make applicable the incidents by law belonging to that relation nor shall any agreement between the parties be necessary to give the landlord the right of distress.

(2) It is hereby declared that the said section was intended to express the same meaning as this section and no other.

[53]      Justice Rose described the amended provision in Kennedy v. Agricultural Development Board (1926), 1926 CanLII 323 (ON SC), 59 O.L.R. 374 (H.C.), which is the leading case on s. 3. In Kennedy, there was a question whether an owner in fee simple could also be a tenant under an attornment clause in a mortgage agreement even if there was no reversion in the chargee. The attornment clause stated that “[t]he mortgagor hereby attorns to the Board and becomes tenant of the said lands during the term of this mortgage”. Rose J. concluded that “in Ontario the basis for holding that the attornment clause is ineffective as against persons other than the parties and their privies [was] swept away by s. 3”: at p. 376.

[54]      Rose J. went on to discuss the effect of s. 3 at p. 378:

The relation cannot depend on the landlord’s tenure, but, apart from the statute, it does depend upon the tenant’s tenure from the landlord. Therefore, in my opinion, the statutes of 1896 and 1914 must mean that a man can be tenant although he does not hold from the landlord; and, as I have said, if he can be tenant without holding from the landlord, I do not see what is to prevent his being at one and the same time holder in fee simple and tenant to the landlord.

[55]      There have been only a few cases since Kennedy that discuss the interpretation of s. 3 or even mention it. In Wotherspoon v. Canadian Pacific Ltd. (1979), 1979 CanLII 2049 (ON SC), 22 O.R. (2d) 385 (H.C.), Hughes J. commented on s. 3, at p. 523:

…I should append a note about one aspect of a lease which I suggested earlier must be for a term less than the life of the interest of the lessor. Such was the invariable principle observed by the common law, but by 1896 (Ont.), c. 42, s. 3, the substance of the provision which is still s. 3 of the Landlord and Tenant Act, R.S.O. 1970, c. 236, was introduced into the law of Ontario…

So in Ontario at least the distinction between a lease and an assignment was obliterated and the term of a lease could be coterminous with the extent of the interest of the lessor.

[56]      The appeal from Hughes J.’s decision was allowed, although this court did not comment on s. 3. The matter went to the Supreme Court, which dismissed the appeal and allowed the cross-appeal: 1987 CanLII 2807 (SCC), [1987] 1 S.C.R. 952. The Supreme Court affirmed the “ancient” common law but noted the existence of what became s. 3 of the CTA, at p. 1016:

An underlease of the whole term of a lease operates as an assignment in law… Furthermore, if a lessee for a term of years makes a lease for a term greater than his own, this second lease operates as an assignment… but see Anger and Honsberger Law of Real Property (2nd ed. 1985), vol. 1, pp. 259-64, for a comment on a possible interpretation of s. 3 of the Landlord and Tenant Act, R.S.O. 1980, c. 232 on this point.

[57]      In Goldman, this court considered the impact of s. 3 of the CTA on the common law rule requiring a reservation of the last day of the head lease term. In that case, the parties executed a commercial lease for two units in a shopping centre. The lease contained an option to purchase and a right of first refusal to purchase the entire shopping centre. During the term of the lease, with the consent of the landlord, the tenant entered into a sublease. The sublease was for the entirety of the leasehold term but did not include the option or the right of first refusal. Subsequently, the tenant gave notice of the exercise of the option. However, the landlord took the position that the tenant could not exercise the option due to its failure to reserve the last day of the head lease term. The landlord then brought a successful application for a declaration supporting its position, and the tenant appealed.

[58]       This court’s analysis of the impact of s. 3 of the CTA was as follows:

[4] [The application judge] would not adopt the appellant’s argument that s. 3 of the Commercial Tenancies Act, R.S.O. 1990, c. L.7 supersedes the common law. That section provides in part, ‘[t]he relation of landlord and tenant does not depend on tenure and a reversion in the lessor is not necessary in order to create the relation of landlord and tenant . . . .”

[5] The appellant traces this provision, unique to Ontario and, at one time, Ireland, through various statutes back to 1860 in Ireland. In the only Ontario case dealing with the section, Harpelle v. Carroll (1896), 27 O.R. 240 (Q.B.) and in a context of permitting distress, Meredith C.J. had this to say at p. 246 O.R.:

It is highly probable that if the framer of the Ontario Act, had had before him the caustic criticism which the Irish Act as a whole, and its several parts, including section 3, — as would appear from the reports of the cases to which I shall afterwards refer, — received from the Judges of the Courts of that country during the short time the Act was in force there, he would have chosen different language to express the idea which he probably had, that of doing away with the necessity of the having of the immediate reversion to entitle to distrain one who had let lands to another.

[6] I would not be so dismissive of the legislative intent but do sidestep consideration of its application to the present facts. In my view, the motions judge erred in another respect, which is sufficient to dispose of the appeal, and I leave resolution of any conflict between the statute and the common law for another day when the broader ramifications of altering the course of landlord and tenant law in Ontario alone can be adequately canvassed.

[59]      Given the dearth of jurisprudence, academic commentary on this section is helpful. In the 1985 version of Anger & Honsberger, at p. 260, the authors note:

The plain language of this section would lead me to assume that a tenant could create a sublease notwithstanding his failure to reserve to himself some residue of the original term.

[60]      In discussing s. 3 of the CTA, these authors refer to comments by Edward Douglas Armour, Q.C., in A Treatise on the Law of Real Property,1st ed. (Toronto: Canada Law Book, 1901). Like others, Mr. Armour expressed surprise and uncertainty about the 1895 and 1896 legislation, at p. 135:

It will be noticed that the present enactment contains no affirmative declaration that the relationship is to depend on contract, but contains simply four negatives, of which one is that the relationship of landlord and tenant is not to depend on tenure. The notion of an estate in land being inseparable from tenure, it may be that the consequence of the abolition of tenure in this connection reduces the relationship of landlord and tenant to a contract of hiring of land, and that there is no such thing, properly speaking, as an estate for years in land arising from the making of a lease. It was held in Harpelle v. Carroll, however, that the first enactment did not abolish the relationship of landlord and tenant and make the bargain a mere contract, but merely altered the mode of creating the ancient relationship. If this be the effect of the enactment, then it worked no change in the law, except that the relationship may probably now exist where the so-called landlord parts with his whole interest in the land, retaining no reversion, thus extending the whole law of landlord and tenant to such a case. [Citations omitted.]

[61]      The current edition of Anger & Honsberger, cited above, reiterates what was said about s. 3 in the earlier edition of the text: at §7:10. The only case it cites is Kennedy. It also references Professor Scane’s article. In that article, he says that “[t]he effects of [the] section are obscure” and describes s. 3 as “curious” and “mysterious”: at pp.3-5. He muses about the section as follows, at pp. 4-5:

As I sat preparing this lecture, wondering why such a curious section should be in the Ontario Act ̶ a section which politely thumbs its nose at several centuries of accumulated law, and yet sits in dusty obscurity, unnoticed by most of flipping through the Act on our way to Part III ̶ I began to wonder whether we are not missing a bet in Ontario, and whether it might not be time to drag this section into the light and have a good look at it.

The section also poses another interesting problem. Anywhere but in Ontario, or other jurisdictions, if any, having a similar section, a tenant who assigns the whole of the remaining term of his lease creates an assignment, not a sub-lease. If you desire a sub-lease, you must reserve part of the term to the original tenant. Is it possible under the Ontario statute to create a sub-lease of the entire balance of the term? On a literal reading, it would seem so.

[62]      It would appear that the time has come for this court to determine how s. 3 of the CTA impacts the common law requirement to reserve the last day of a head lease term in a sublease.

(e)         Impact of s. 3 of the CTA on the Common Law

[63]      Before turning to a consideration of the impact of s. 3 of the CTA on the common law, a word about the Canadian cases referred to above that expand the definition of a reversionary interest beyond a temporal reservation. Recall that Hazelton relied on one of these cases, Letourneau, in its submission to the application judge.

[64]      I would not import these cases into Ontario law for two reasons. First, they expand the notion of a reversionary interest in a manner that appears to be results-driven and without regard to hundreds of years of jurisprudence that makes clear that an assignment is made when no temporal reservation is made. Second, the decisions of the Alberta and Nova Scotia courts to expand the meaning of a reversionary interest at common law were made in a legal milieu where there was no equivalent to s. 3 of the CTA. That said, I make no comment on the result in Elia or Anthem, which dealt with subleases of only portions of the leased premises. The sublease in the case at bar was for the whole premises.

[65]      In assessing the impact of s. 3 of the CTA, it is important to focus on the breadth of the provision. The section makes clear that a reversion in the lessor is not necessary in order to create the relationship of landlord and tenant. What the section does not say is what, in fact, is necessary to create that legal relationship.

[66]      If we accept, based on the plain wording of s. 3, that a reversionary interest is not required, it is possible to conclude that there is no need to reserve the last day of the lease term for there to be a landlord and tenant relationship. In that case, it would be unnecessary to engage in the type of analysis undertaken in the three outlier cases cited above, where courts searched for a reversionary interest that went beyond temporal limits.

[67]      In my view, there is a danger in interpreting s. 3 to mean that a landlord and tenant relationship is always established between the purported sublessor and subtenant regardless of whether there is a reversionary interest. The danger is that the distinction between subleases and assignments would be lost. This would be contrary to the provisions of the CTA, which maintain such a distinction: see ss. 23(2) and 25. It could also have a disruptive effect on existing transfers where the last day of the head lease term has not been reserved. Recall that it was suggested by Mr. Gold that in those cases the failure to reserve the last day is usually deliberate in order to create an assignment.

[68]      Reading s. 3 in context, I interpret it to mean that there may be a sublease even if the last day in the head lease is not reserved, but only when there is sufficient evidence to show that the objective intention of the parties, as reflected in the sublease, was not to create an assignment. Recognizing that a commercial lease is not only a conveyance but also a contract, courts should be permitted to consider the objective intentions of the parties to a purported sublease in order to determine the nature of the impact on the subletting party vis-à-vis its rights under the head lease. In other words, a party may demonstrate that, notwithstanding a failure to reserve the last day of the head lease term, an assignment was not intended by the parties.

[69]      Interpreting s. 3 in such a way maintains the distinction between subleases and assignments, which is consistent with the scheme of the CTA. It is also consistent with the wording of s. 3.

[70]      Practically speaking, this interpretation does not have the effect of forcing parties to continue a legal relationship when they have no desire to do so. In addition, I do not anticipate that the impact of this approach will be far-ranging because I expect that most parties to a commercialsublease will follow the usual practice and simply reserve the last day in order to avoid an assignment. However, in the limited number of cases where that is not done and the tenant under the head lease wishes to maintain its rights under the head lease, it may be possible to prove that an assignment was not intended by examining the terms of the purported sublease.

(f)           Application to the Case at Bar

[71]      There is no question that Hazelton failed to reserve to itself the last day of the head lease term. In the absence of s. 3 of the CTA, the purported sublease would have operated as an assignment.

[72]      The question that remains is whether the sublease provides sufficient evidence to show an intention to maintain a landlord and tenant relationship between Hazelton and Perfect Smile. In my view, it does.

[73]      On the plain wording of section C of Schedule “A” in the sublease, it is clear that the parties turned their minds to the impact of the sublease on Hazelton’s rights under s. 7 of the head lease. In section C, the parties agreed as follows:

Sub-lease: notwithstanding that the head Lease contains a provision allowing the tenant to renew the Lease for a further term as set out therein, there is no obligation by the Sub-Landlord to renew in favour of the Sub-Tenant and the Sub-Tenant acknowledges that they no such right of renewal or extension of the Lease. The Sub-Lease is only for the term set out herein.

[74]      This provision makes plain that Hazelton has a right to renew the lease but that it is not obliged to renew on behalf of Outhere. It further makes clear that Outhere has no right to renew and that its rights under the sublease expire at the end of the term.

[75]      In my view, despite the fact that Hazleton did not reserve to itself the last day of the head lease term, the sublease provides sufficient evidence that the parties did not intend an assignment. Accordingly, I would not treat the sublease as an assignment and would hold that Hazelton has the right to renew the lease provided that it exercises its renewal right in accordance with the terms of the lease. I will consider Perfect Smile’s argument about compliance with the renewal term in the next section of my reasons.

(g)         Breach of Lease

[76]      In the alternative, Perfect Smile argues that Hazelton has no right to renew the lease because, at the time of the putative renewal, Hazelton had breached the lease. Specifically, Perfect Smile submits that Hazelton breached the lease by removing the bathroom from the premises without its permission.

[77]      The application judge found that Perfect Smile “knew of the renovation and the missing bathroom at least by early 2017, since its principal deposes in his affidavit that this is when he discovered the fact that the bathroom had been removed”. The application judge noted that the respondent failed to give notice to Hazelton of any objections to the bathroom renovations. He also found that Perfect Smile’s “complaint about the state of the Premises is a position adopted late in the day in order to justify its dealing directly with Chaves.”

[78]      The application judge misstated Perfect Smile’s principal’s evidence when he stated that the principal testified that he found out in early 2017 about the removal of the bathroom. In fact, the principal stated that he found the information out at some unspecified date in 2017.

[79]      Despite this misstatement, I am of the view that it was open to the application judge to find that Perfect Smile knew about the removal of the bathroom and that it was using the removal to justify its dealing with Mr. Chaves. There was uncontested evidence that the principal of Perfect Smile knew generally about the renovations. In addition, as discussed above, the principal admitted that he knew specifically about the removal of the bathroom in 2017. Further, these findings are supported by the “With Prejudice” letter of September 28, 2017 written by counsel for Perfect Smile, Robert W. Trifts. In that correspondence, Mr. Trifts cites the failure to reserve the last day of the head lease term and the allegedly vague wording of the right to renew as the reasons why Hazelton cannot renew the lease. The only reference to the bathroom comes at the very end of the letter and refers to a potential claim for damages. Mr. Trifts does not purport to support Perfect Smile’s position that the lease could not be renewed on the basis of the bathroom renovation.

[80]      In summary, there is no basis to interfere with the application judge’s conclusion that Hazelton did not breach the lease.

(iii)        Damages

[81]      The application judge undertook a damages analysis. He remarked that he did not know what rent the arbitrator would have fixed. Nor did he know whether it would have been profitable for Hazelton to sublet the premises. However, he assumed that the rent paid by Outhere reflected fair market value. Based on that assumption, he concluded that Hazleton had suffered no damages because it could only have sublet the premises at the same rate it was paying Perfect Smile.

[82]      The notice of application did not seek damages. It sought declaratory and injunctive relief exclusively related to Hazleton’s right to reoccupy the premises and renew the lease. We expect litigants to limit the evidence they tender and the arguments they make to the issues raised within the four corners of their pleadings: Louis Vuitton Malletier S.A. v. Wakilzada, 2017 ONSC 2409 (CanLII), 145 C.P.R. (4th) 253, at para. 15 (reiterating that pleadings establish a benchmark to determine the relevance of evidence).

[83]      The corollary to that proposition is that courts should limit their decisions to the relief sought by the parties: Sobeski v. Mamo, 2012 ONCA 560(CanLII), 112 O.R. (3d) 630; Kalkinis (Litigation guardian of) v. Allstate Insurance Co. of Canada (1998), 1998 CanLII 6879 (ON CA), 41 O.R. (3d) 528 (C.A.). This case illustrates the dangers of straying from what is actually in issue. The application judge commented that he had little evidence before him to determine the issue of damages. There was a reason for that: Hazleton was not seeking damages and did not therefore tender evidence in support of a damages claim.

[84]      The application judge erred in undertaking a damages analysis in these circumstances. His order finding that Hazelton suffered no damages must be set aside.

(iv)        Costs of the Application

[85]      Perfect Smile seeks leave to appeal the costs award made by the application judge, and requests an order for costs payable to it for the application. Given the disposition of the substantive issues on this appeal, leave is refused. Instead, I would order that Hazelton is entitled to an order for its costs of the application payable by Perfect Smile.

[86]      I would not interfere with the application judge’s order regarding costs for the Chaves respondents. Mr. Chaves was found to have breached his obligation to act in good faith and thus it is an equitable result that he should not be awarded his costs. He played a minor role on the application, so I would not order him to pay costs to Hazelton.

(v)         Mr. Chaves’ Deposit

[87]      The application judge ordered that the $10,000 deposit paid by Mr. Chaves be returned to him. That order was not challenged on appeal.

Part V: Disposition

[88]      I would allow the appeal and set aside the judgment of the application judge, save for the order for the return of Mr. Chaves’ deposit. Further, I would grant  an order:

(1)  Declaring that Hazelton has rightfully exercised its option to renew the lease for a five-year period starting October 1, 2017, and as a result has a right to lease the premises for that period;

(2)  Requiring Perfect Smile to give possession of the premises to Hazelton as soon as possible, subject to item (5) below, and restraining Perfect Smile from denying possession or purporting to lease the premises to any other party in contravention of Hazelton’s leasehold rights;

(3)  Requiring Perfect Smile and Hazelton to submit to arbitration as contemplated under the lease to determine the rent;

(4)  Declaring that the Chaves respondents no longer have any leasehold interest in the premises, and that any agreement or arrangement with Perfect Smile to the contrary is void; and

(5)  Requiring the Chaves respondents to give possession of the premises to Hazelton as soon as possible, and at any rate within 30 days of the release of these reasons.

[89]      If Hazelton and Perfect Smile cannot agree on the costs of the application below, they may make written submissions to this court.

[90]       The Chaves respondents played a minor role on the appeal akin to interveners. In the circumstances, I would make no order for or against them for costs. Instead, I would order Perfect Smile to pay the costs of the appeal to Hazelton in the all-inclusive sum of $12,000.

Released: “D.W.” May 23, 2019

“C.W. Hourigan J.A.”

“I agree. David Watt J.A.”

“I agree. Grant Huscroft J.A.”