COURT OF APPEAL FOR ONTARIO
LASKIN, ROSENBERG AND LAFORME JJ.A.
B E T W E E N :
473807 ONTARIO LIMITED
Alistair Riswick for the respondent
Applicant/Respondent
- and -
THE TDL GROUP LTD.
Paul Bates for the appellant
Respondent/Appellant
Heard: November 4, 2005
On appeal from the judgment of Justice Michael R. Dambrot of the Superior Court of Justice, dated March 9, 2005 made at Toronto, Ontario.
LASKIN J.A.:
A. OVERVIEW
1The broad question on this appeal is which of two innocent parties – the appellant tenant, The TDL Group Ltd., or the respondent mortgagee, 473807 Ontario Limited – should suffer because of the irresponsible conduct of an impecunious landlord/mortgagor. The specific question is whether the terms of a postponement and non-disturbance agreement made between the tenant and the mortgagee permit the tenant to set off, against rent owing to the mortgagee under a lease, the amount of a judgment the tenant had obtained against the landlord.
2These are the bare facts. The tenant leased property from the landlord. The landlord then mortgaged the property, and gave the mortgagee an assignment of rents as collateral security for the mortgage. The tenant and the mortgagee signed a postponement and non-disturbance agreement: the tenant agreed to postpone its lease to the mortgage; the mortgagee agreed that if it went into possession, it would take over the landlord’s interest in the lease and would not interfere with the tenant’s rights under the lease.
3The tenant successfully sued the landlord for damages for breach of the lease and costs. The court ordered that the tenant was entitled to set-off its damages and costs award against its rent. The landlord defaulted on the mortgage. The mortgagee went into possession. The tenant claimed that it could apply its court ordered set off against the rent payable to the mortgagee. The mortgagee resisted. The postponement and non-disturbance agreement does not specifically mention set-off.
4On an application to determine the rights of the tenant and the mortgagee, the motion judge found for the mortgagee. He concluded that the postponement and non-disturbance agreement did not explicitly or implicitly preserve the tenant’s right of set-off and therefore the tenant could not apply its court ordered set-off against its rent. The motion judge concluded in the alternative, that the mortgagee was not bound by the set-off because it was not a party to and did not have notice of the tenant’s litigation with the landlord.
5The tenant TDL appeals. Its appeal raises two issues: first, do the terms of the postponement and non-disturbance agreement entitle TDL to set-off against its rent payable to the mortgagee the amount of its judgment against the Landlord; and, second, is TDL’s judgment against the landlord binding on the mortgagee, though the mortgagee was not a party to that litigation? For the reasons that follow, I would answer yes to both questions.
B. BACKGROUND FACTS
6The motion judge has admirably and succinctly set out the relevant facts, none of which are disputed. Here, I will summarize only those facts necessary for my decision.
a. The lease between the TDL Group Ltd. and 1158631 Ontario Limited.
71158631 Ontario Limited. (“the Landlord”) owned one acre of land on the south side of Highway 7 in Markham, Ontario. By an agreement made in June 1998, The TDL Group Ltd. leased a part of this land from the Landlord. TDL is the franchisor of the national brand “Tim Hortons” and, through franchisees, it operates the chain of Tim Hortons restaurants.
8The original lease was amended by an agreement dated April 27, 1999, under which TDL, at its own expense, built a large Tim Hortons restaurant and drive-through. The lease was registered on title. The restaurant opened for business in January 2000.
9The lease as amended (“the Lease”) has a 20-year term, and TDL has an option to renew for a further five years. Rent for the first five years of the Lease was fixed at $25,000 annually. The Lease stipulated that rent increased by $5,000 annually in succeeding five-year periods. Thus, for the last five years of the Lease (years 16-20), the rent will be $40,000 a year.
10Section 2.01 of the Lease provides that rent is to be paid “without any set off” except as provided in s. 13.01. If the Landlord defaults in performing one of its covenants under the Lease, s. 13.01 gives TDL the right to cure the default and set off against rent the expenses incurred in doing so.
11Under s. 6.06 of the Lease, the Landlord must indemnify TDL for any losses, damages and costs arising out of the Landlord’s breach or failure to perform its obligations under the Lease. However, the Lease does not appear to give TDL a right of set off where the Landlord is liable for damages under s. 6.06.
12Section 20.01 of the Lease is headed “conditions”. Section 21.01(e) requires, as a condition of the Lease, that the Landlord obtain a non-disturbance agreement for its tenants from its mortgagees.
b. The mortgage between the Landlord and 473807 Ontario Limited
13In November 1999, 473807 Ontario Limited (“the Mortgagee”) loaned the Landlord $475,000 and took back a first mortgage on the land as security. As further security for its loan, the Mortgagee took an assignment of rents, entitling it to collect rent from the Landlord’s tenants if the Landlord defaulted under the mortgage. In the assignment of rents, the Landlord covenanted as assignor to “observe and perform all of its obligations under the leases.” Both the mortgage and the assignment of rents were registered on title.
c. The postponement and non-disturbance agreement
14Contemporaneously with the mortgage, and as contemplated by the Lease, TDL and the Mortgagee entered into a postponement and non-disturbance agreement (“PNDA”). TDL drafted the PNDA, and it was signed without negotiation. The terms of the PNDA are crucial to the outcome of this appeal, and I will refer to them in detail when I discuss the legal issues.
15In general terms, TDL agreed to postpone its Lease to the mortgage. In return, the Mortgagee agreed that if it enforced its security, and TDL was not in default, TDL could remain in possession and carry on business under the terms and conditions of the Lease. TDL agreed to promptly attorn to the Mortgagee, and the Mortgagee agreed to be bound as the landlord under the Lease.1
d. TDL’s damages action against the Landlord
16On April 25, 2000, without justification, the Landlord posted a termination notice on the door of the restaurant, evicted everyone inside, and sought to close down the business. The next day, TDL and its franchisee obtained an order returning possession of the premises to them, and directing the Landlord to honour its covenant to provide TDL with quiet enjoyment. TDL then sued the Landlord – aptly described by counsel as “the landlord from hell” – for breach of the Lease, trespass, interference with economic relations and defamation.
17The action was tried before Blenus Wright J. in early 2003. He found the Landlord liable on the claims asserted by TDL and its franchisee and assessed damages at $62,487.30, including $10,000 in punitive damages. He also awarded TDL and its franchisee substantial indemnity costs, which were later assessed at $644,922.91, an amount the motion judge termed “astounding”.
18Significantly for the present appeal, Blenus Wright J. concluded that “the facts of this case support a legal and equitable set-off”. His formal judgment included a paragraph entitling TDL to set off against rent and other monies due to the Landlord under the Lease, the amount of the damages award together with costs, a sum of approximately $707,000. The Landlord appealed Blenus Wright J.’s judgment but did not challenge TDL’s right of set off. This court dismissed the appeal.
e. The Mortgagee goes into possession
19In November 2003, the Landlord defaulted on its mortgage. In February 2004, the Mortgagee issued a notice of sale. The Mortgagee also gave notice to TDL that it had succeeded to the interest of the Landlord under the Lease and that TDL was obliged to pay it rent in accordance with the assignment of rents. But TDL took the position that the judgment of Blenus Wright J. entitled it to set off against rent otherwise owing to the Mortgagee, the $707,000 in damages and costs awarded against the Landlord.
20In June 2004, the Mortgagee obtained an order for possession and went into possession of the premises.
f. The litigation between TDL and the Mortgagee
21Once the Mortgagee went into possession under the terms of the PNDA, TDL and the Mortgagee came into privity of contract. The Mortgagee then contended that the PNDA gave it the right to attorn rent without giving effect to TDL’s right of set-off against the Landlord. TDL contended that, though it did not respond to the attornment, it was not in default under the Lease because of its right of set-off, and, therefore, it was entitled to remain in possession of the leased premises.
22To resolve the dispute the Mortgagee brought an application for a declaration that TDL was obliged to pay rent in accordance with the Lease and that TDL could not set off its judgment against the Landlord against that rent. The motion judge granted both declarations.
C. DISCUSSION
23As I said earlier, this appeal raises two issues: first, does the PNDA entitle TDL to set off against its rent payable to the Mortgagee the amount of its judgment against the Landlord; and second, is TDL’s judgment against the Landlord binding on the Mortgagee?
First Issue: Does the PNDA entitle TDL to set off against its rent payable to the Mortgagee the amount of its judgment against the Landlord?
24The motion judge concluded that TDL was not entitled to set off its judgment against the rent payable to the Mortgagee. He held that the state of accounts between the Landlord and TDL would be incorporated into the tenancy between TDL and the Mortgagee, only if the PNDA so provided, either explicitly or implicitly. And he held that the PNDA did not so provide. In other words, he concluded that the Mortgagee and TDL began their leasehold relationship with a “clean slate.”
a. The positions of the parties
25In this court, the Mortgagee advanced three main arguments in support of the motion judge’s decision. First, it argued that the motion judge’s “clean slate” approach was correct. According to the Mortgagee, the PNDA created a new lease between TDL and the Mortgagee, a lease that incorporated by reference the terms of the existing lease between TDL and the Landlord, and that came into existence when the Mortgagee took possession of the premises under its mortgage security.
26Second, the Mortgagee argued that the court should not interpret the PNDA literally when doing so would not yield a sensible commercial result. Interpreting the PNDA to give TDL a right of set-off, the Mortgagee contended, would be commercially unrealistic.
27Finally, and in the alternative, the Mortgagee argued that the PNDA was ambiguous on whether TDL was entitled to set off its judgment against its rent. The Mortgagee then contended that because TDL was a sophisticated party that insisted on using its own form of a postponement and non-disturbance agreement, the court should apply the contra proferentum rule and construe the ambiguity against TDL’s position.
28In support of its appeal, TDL also put forward three arguments. Its main argument was that the motion judge’s “clean slate” approach is wrong in law and contrary to the unambiguous terms of the PNDA. TDL contended that the PNDA created privity of contract between it and the Mortgagee and that by its terms, the Mortgagee simply took over the Landlord’s position under the Lease. Thus, absent an agreement to the contrary, the Mortgagee was bound by the state of accounts between TDL and the Landlord, which included TDL’s right of set-off. In short, the Mortgagee took over the Lease “subject to the equities”. And far from amounting to an agreement to the contrary, the terms of the PNDA confirmed that TDL’s right of set-off was preserved.
29Second, TDL argued that the PNDA created privity of estate between it and the Mortgagee. As the Landlord’s covenants, whose breach gave rise to TDL’s equitable set-off, like the tenant’s covenant to pay rent, ran with the land, they were binding on the Mortgagee. Moreover, TDL contended that the cases the motion judge relied on to support his clean slate theory do not assist the Mortgagee because they concern personal covenants of the Landlord, not, as here, covenants that ran with the land.
30Third, TDL argued that its position is commercially sensible and that the Mortgagee simply failed to protect itself by either obtaining an estoppel certificate or an appropriately worded PNDA.
31Despite their competing positions, both counsel recognized, as indeed did the motion judge, that the rights and obligations of TDL and the Mortgagee are governed by the terms of the PNDA, to which I now turn.
b. The PNDA
32Because the PNDA dictates the outcome of this appeal, I set it out below in its entirety. I have underlined the parts that I consider especially significant.
POSTPONEMENT & NON-DISTURBANCE AGREEMENT
THIS AGREEMENT made this 18th day of November, 1999.
BETWEEN:
THE TDL GROUP LTD., a company
incorporated under the laws of
the Province of Ontario
(hereinafter “TDL”)
OF THE FIRST PART
-and-
473807 ONTARIO LIMITED
(hereinafter the “Mortgagee”)
OF THE SECOND PART
AND WHEREAS Corporation is a party to a Lease made as of the 17th day of June, 1998 and amended by an Amending Agreement dated the 27th day of April, 1999 (collectively the “Lease”) made between TDL, as tenant (the “Tenant”), and 1158631 Ontario Limited, as Landlord (the “Landlord”), made between the Landlord and Tenant with respect to certain lands (the “Lands”) in the City of Markham, Province of Ontario, which Lands are more particularly described in Schedule “A” attached hereto;
AND WHEREAS the Landlord has granted a mortgage to the Mortgagee dated the 22nd day of November, 1999, and registered on the 25th day of November, 1999 as Instrument Number ________ (the “Mortgage”) against the Lands;
AND WHEREAS the Mortgagee requires priority with respect to its rights and privileges under such Mortgage over the Lease;
NOW THEREFORE in consideration of Ten ($10.00) Dollars now paid by the Mortgagee to Corporation, the receipt of which is hereby acknowledged, it is agreed as follows:
Tenant hereby postpones its Lease to the Mortgage on the terms and conditions set forth below;
Tenant acknowledges that, subject to compliance with paragraph 3 below, the rights and privileges of the Mortgagee under the Mortgage shall have priority over Tenant’s Lease and agrees upon a lawful request of the Mortgagee at any time and from time to time, the Tenant shall promptly attorn to the Mortgagee and become the Mortgagee’s tenant under the Lease, or the tenant of any purchaser from the Mortgagee in the event of an exercise of any permitted power of sale contained in the Mortgage, such attornment to be for the then unexpired residue of the term of the Lease, and upon all terms and conditions of the Lease, provided that the Mortgagee or such purchaser is bound as the landlord under the Lease.
3.1. The Mortgagee covenants that if, at any time, it shall enforce its security under the Mortgage, Tenant, if not in default under the terms of the Lease (including the payment of rent or additional rent), shall be entitled to remain in possession of the leased premises as described and defined in the Lease according to the terms and conditions thereof (including any amendments that may have been agreed to by the parties to the Lease prior to the date of such enforcement) for the then unexpired residue of the term of the Lease, and any renewals or extensions thereof. Notwithstanding the above, for the purposes of this clause, the Tenant shall not be in default if it is in the process of diligently rectifying a default within the time set out in the Lease.
3.2. Notwithstanding anything herein to the contrary, Tenant shall be under no obligation to pay rent to the Mortgagee until Tenant receives written notice from the Mortgagee that it has succeeded to the interest of the Landlord under the Lease.
Nothing herein shall create the relationship of landlord and tenant between the Mortgagee and Tenant unless and until the Mortgagee shall enter into possession of the premises by virtue of its rights under the Mortgage.
Tenant agrees not to prepay any rent or additional rent unless so required under the terms of the Lease and that the Mortgagee shall not be liable for any rent or additional rent which Tenant may have paid for more than the current month to the Landlord unless required under the provisions of the Lease.
The Mortgagee hereby acknowledges and confirms that it has received a copy of the Lease.
The covenants and agreements contained herein shall extend to, be binding upon and enure to the benefit of the successors and assigns of each of the parties hereto respectively.
33This is a case of contract interpretation. It turns on the interpretation of the PNDA. As I interpret the PNDA, the parties intended that when the Mortgagee went into possession, the Mortgagee would take over the Landlord’s position under the Lease, and TDL would be in the same position as it was when the Landlord was the lessor. Thus, in my view, the parties intended that when the Mortgagee took over the Landlord’s position, apart from any prepayment of rent, the Mortgagee would assume the state of accounts between the Landlord and TDL. That state of accounts included TDL’s right to set off its judgment for damages and costs against its rent. This interpretation gives effect to the words of the PNDA, is consistent with the law of assignment, and reflects commercial practice.
i. The interpretation of the PNDA
34The basic goal of contract interpretation is to ascertain the intent of the parties at the time they entered into the contract. Ordinarily, the parties’ intent is determined by the words of the contract, viewed in the light of relevant surrounding circumstances. See Eli Lilly and Co. v. Novopharm Ltd., [1998] 2 S.C.R. 129 at para. 54. I therefore propose to examine the words of the PNDA.
35The PNDA created privity of contract between the Mortgagee and TDL, a privity that did not otherwise exist. Under s. 4, once the Mortgagee went into possession, the PNDA established a landlord and tenant relationship between the Mortgagee and TDL.
36The core bargain struck under the PNDA was TDL’s agreement to postpone its Lease to the mortgage (that is to give the mortgage priority over the Lease (s. 1)) in return for the Mortgagee’s agreement to give TDL security of tenure (s. 3.1). As long as TDL paid the rent required by the Lease, the Mortgagee would not disturb TDL’s possession of the premises. The postponement provision of the PNDA reordered priorities, but did not otherwise affect the rights and obligations of the Mortgagee and TDL. Those rights and obligations depend on the other terms of the PNDA.
37The other terms of the PNDA show that when the Mortgagee went into possession, it would step into the Landlord’s shoes and assume the Landlord’s obligations under the Lease. These obligations included recognizing TDL’s court-ordered right of set-off. TDL was to be no worse off in a tenancy relationship with the Mortgagee than it was under its tenancy with the Landlord. That this was the parties’ intent is demonstrated by the following provisions of the PNDA:
The PNDA refers to the “Lease” (first recital). The “Lease” is a defined term. It means the lease agreement between the Landlord and TDL.
The Mortgagee’s act of going into possession created a landlord-tenant relationship between it and TDL (s. 4).
The Mortgagee agreed to be “bound as the landlord under the Lease” (s. 2). In other words, the Mortgagee agreed to accept the Landlord’s obligations under the Lease. One binding obligation of the Landlord was to recognize TDL’s court ordered set-off.
Once the Mortgagee agreed to be bound as the landlord, TDL agreed to “attorn” to the Mortgagee, that is to recognize the Mortgagee as its landlord (s. 2); and TDL also agreed to become the Mortgagee’s tenant under the Lease, “upon all terms and conditions of the Lease.” One term of the Lease is TDL’s obligation to pay the stipulated rent.
The Mortgagee agreed that if it enforced its security, as long as TDL was not in default, TDL could remain in possession under the terms of the Lease (s. 3.1).
TDL’s obligation to pay rent to the Mortgagee was triggered by the Mortgagee’s notice that it had “succeeded to the interest of the Landlord under the Lease”. (s. 3.2). The Landlord’s interest under the Lease was encumbered by TDL’s court-ordered right of set off.
The parties agreed that the Mortgagee would not be liable for any rent TDL had prepaid to the Landlord (s. 5). Section 5 is relevant to the parties’ intent in two ways. First, it is a strong indicator that the Mortgagee agreed to assume the state of accounts between the Landlord and TDL. If it did not agree to do so, s. 5 would have been unnecessary.
Second, s. 5 invokes the principle of interpretation “to express one thing is to exclude another” (expressio unius est exclusio alterius). In other words, by exempting prepayment of rents from the state of accounts taken over by the Mortgagee, the parties must have intended not to exempt any other items. See John D. McCamus, The Law of Contracts (Toronto: Irwin Law Inc., 2005) at 726.
Professor McCamus makes the valid point that this principle should be applied cautiously because a missing reference may be an accidental omission. However, postponement and non-disturbance agreements are commonly used in the field of commercial real property. The PNDA, itself, was agreed to by two commercial lawyers. In this context, I do not see any room to argue that the absence of a provision, similar to s. 5, for set-off was accidental, even though the amount of the set-off was undoubtedly unanticipated. Nor, in the light of the specific reference to prepayment of rent, do I see any room to argue that the parties implicitly intended to exclude set-off from the state of accounts.
38Thus, I conclude that under the PNDA, the Mortgagee agreed to take over the Landlord’s position under the Lease and to assume responsibility for whatever set-off rights TDL acquired against the Landlord.
39The motion judge stopped short of saying that when the Mortgagee went into possession, a new lease came into effect. He seemed to accept implicitly what I have said explicitly: the Mortgagee stepped into the position of the Landlord under the original Lease. However, we differ in the effect of the Mortgagee’s having done so.
40The motion judge concluded that the Mortgagee and TDL began with a clean slate because TDL’s right of set-off was not incorporated, expressly or implicitly, into their leasehold relationship. Respectfully, the motion judge did not give effect to the words of the PNDA and especially did not give effect to s. 5. In my view, the words of the PNDA, require a conclusion opposite to that of the motion judge.
41The motion judge supported his conclusion by reference to three cases, which he fairly conceded were not “on all fours”, but which he thought supported his underlying “clean slate” approach. I do not consider these cases relevant.
42The three cases are: Chiappino v. Bishop (1988), 49 R.P.R. 218 (Ont. Dist. Ct.); Devon Estates Ltd. v. Royal Trust Co. (1994), 24 Alta. L.R. (3d) 401 (Q.B.); and Dollar Land Corp. Ltd. v. Solomon, [1963] 2 O.R. 269 (Ont. H. C.). In each case, the tenant had made a prepayment of one kind or another to a predecessor landlord. The tenant then sought recovery of the prepayment from a successor landlord. In each case, recovery was denied. In none of the three cases, however, did privity of contract exist between the tenant and the successor landlord. Thus, the successor landlord would be liable for the prepayment only if there was privity of estate between it and the tenant, and the original landlord’s covenant to repay “ran with the land.” See R.E. Megarry and H.W.R. Wade, The Law of Real Property (London: Sweet & Maxwell Ltd., 2000) at para. 15-004. In each case, the court held that the landlord’s covenant to repay was a personal covenant and did not run with the land. Thus, the successor landlord had no obligation to make the repayment.
43None of the three cases relied on by the motion judge turns on contractual rights and obligations, because, unlike the present case, in those three cases there was no privity of contract between the tenant and the successor landlord. I note in passing, however, that the result in those three cases was specifically addressed in s. 5 of the PNDA.
44I add that TDL did seek to distinguish the three cases relied on by the motion judge. TDL did so in support of its alternative argument that it and the Mortgagee were in privity of estate, and that the right to set off against rent arising from the Landlord’s breach of the Lease ran with the land. Thus, on this alternative basis, TDL contended that its court-ordered set-off was binding on the Mortgagee. I need not address this alternative argument because TDL and the Mortgagee are bound by a contract, the PNDA, and their rights and obligations are determined by that contract.
45The Mortgagee went a step further than the motion judge and submitted that the PNDA created a new lease between it and TDL, which simply incorporated the terms and conditions of TDL’s Lease with the Landlord. Because the parties had a new lease, the Mortgagee submitted that it did not inherit the state of accounts between TDL and the Landlord under their Lease.
46In my view, the plain words of the PNDA contradict the Mortgagee’s submission. The lease that the Mortgagee agreed to be bound by and under which it succeeded to the interest of the Landlord is a defined term in the PNDA: it is the “Lease” made between TDL and the Landlord. The PNDA did not create a new lease. Rather, it stipulated that the Mortgagee took over the Landlord’s position – or in other words, substituted for the Landlord – under the previously negotiated Lease. Also, I return to the importance of s. 5 of the PNDA. If the PNDA had created a new lease, then s. 5 would have been unnecessary.
47The Mortgagee contended that its “new lease” argument is supported by the reasons of McKinlay J.A. in the important case of Goodyear Canada Inc. v. Burnhamthorpe Square Inc. (1998), 41 O.R. (3d) 321 (C.A.). Goodyear, however, does not assist the Mortgagee. In Goodyear, a mortgage had priority over a lease entered into between the mortgagor and the tenant. This court held that when the mortgagee went into possession, it could not enforce the lease against the tenant. Even though the mortgagee had an assignment of lease and an assignment of rent, these assignments were given only as security for the mortgage debt. They did not create privity of contract between the mortgagee and the tenant. The mortgagee took the assignments but never accepted the obligations of the existing lease. If, however, the mortgagee in possession demanded rent from the tenant, and the tenant paid rent, then these acts established a new year-to-year tenancy between the mortgagee and the tenant.
48Under the PNDA, TDL agreed to postpone its Lease to the mortgage. Thus, like the mortgage in Goodyear, the mortgage here took priority over the Lease. But there the similarities end. What was missing in Goodyear, and what is present here, is privity of contract between the mortgagee and the tenant. Because in Goodyear there was no privity of contract, the parties effectively created a new lease by the acts of demanding and paying rent. McKinlay J.A. observed, however, at 337 that “the normal practice is for the parties to enter into non-disturbance agreements” and that these agreements do create privity of contract.
49In the present case, the Mortgagee and TDL followed this normal practice and under the PNDA they signed, the Mortgagee agreed to accept the Landlord’s obligations under the Lease if it went into possession. For these reasons, I do not accept the Mortgagee’s argument that the PNDA created a new lease and established a new state of accounts.
ii. The law of assignment
50In their annotation of this case – at (2005), 30 R.P.R. (4th) 3 – J. Lem and M. Singerman criticized the motion judge’s decision on the ground that it is contrary to the law of assignment. In the annotators’ view, the Mortgagee was an assignee of the Landlord’s interest in the Lease, and thus bound by the rule that absent an agreement to the contrary, the assignee “takes subject to the equities”. As the PNDA did not exclude TDL’s court-ordered set-off, that set-off was one of the “equities” that the Mortgagee was required to assume.
51In fairness to the motion judge, it does not appear that the law of assignment was argued before him. Moreover, I do not think that the Landlord assigned the Lease to the Mortgagee. The Landlord did not give the Mortgagee an assignment of the Lease. And even if it had done so, it would not have been an absolute assignment because the Landlord still retained the equity of redemption. See Goodyear, supra. The PNDA is not an assignment of the Lease. It does not say that it is, and more importantly, the Landlord did not sign it. The term of the Lease requiring the Landlord to obtain a non-disturbance agreement from its Mortgagee also does not constitute an assignment. The Landlord did give the Mortgagee an assignment of rents, but only as security for the mortgage debt. Moreover, the assignment of rents cannot constitute an assignment of the Lease because in taking the assignment of rents, the Mortgagee did not agree to assume the Landlord’s obligations under the Lease.
52Thus, there is no document or act by which the Landlord assigned and the Mortgagee accepted the Landlord’s rights and its obligations under the Lease. Instead, it was under the PNDA that the Mortgagee agreed to assume the Landlord’s obligations. And the PNDA is not an agreement between the Landlord and the Mortgagee, but an agreement between TDL and the Mortgagee. See the excellent article on assignments by Craig R. Carter, “Assignments of Contracts, Novation and Privity” in Law Society of Upper Canada Special Lectures 2002 Real Property Law: Conquering the Complexities (Toronto: Irwin Law Inc., 2003) 47.
53Nonetheless, I think that the law of assignment is relevant. The Landlord did assign the rents to the Mortgagee. And the Mortgagee relied on its assignment of rents to claim rent from TDL. Although the Mortgagee did not agree in the assignment of rents to accept the Landlord’s obligation under the Lease, it did agree to do so in the PNDA. Therefore, by the assignment of rents and the PNDA, the Mortgagee became the Landlord’s assignee, or at least assumed a position identical to that of an assignee. An assignment substitutes a new party – creditor or debtor – for one of the original parties to the contract. See G.H.L. Fridman, The Law of Contract in Canada, 4th ed. (Toronto: Thomson Canada Limited, 1999) at 710. Here, the Mortgagee stepped into the Landlord’s shoes or substituted for the Landlord under the Lease.
54Therefore, my interpretation of the PNDA is consistent with the rule governing assignments. This rule states that unless there is an agreement to the contrary, an assignee takes subject to all the equities that have accrued at the time the debtor has notice of the assignment.2 See Cheshire, Fifoot and Furmston’s Law of Contract, 14th ed. (London: Butterworths, 2001) at 572-3. As Professor S. M. Waddams explained in his text, The Law of Contracts, 5th ed. (Aurora, ON: Canada Law Book, 2005) at para. 278, the rule that an assignee takes subject to all equities is based on the rationale that “[w]here one of two innocent parties must suffer for the default of the assignor, the law protects the obligor.”
55In the context of this case, the PNDA itself would constitute “notice” to TDL (the debtor) that the Mortgagee (creditor) was stepping into the shoes of the Landlord. TDL agreed to the Mortgagee doing so. By that time, however, TDL had a court-ordered right of set-off against rent payable to the Landlord. Unless TDL and the Mortgagee agreed otherwise, TDL was entitled to assert that right of set-off against its rent payable to the Mortgagee.
56TDL and the Mortgagee did not agree otherwise. They did not agree, explicitly or implicitly, to exclude TDL’s right of set-off. Quite the contrary. The parties agreed that when the Mortgagee enforced its security, the Mortgagee would take over the Landlord’s position under the Lease. That position included the state of accounts then existing between the Landlord and TDL. The parties carved out one exception: prepayment of rent. Otherwise, the Mortgagee was bound by the existing state of accounts, including TDL’s right of set-off.
iii. Commercial practice
57My interpretation of the PNDA also reflects current commercial practice. As the motion judge acknowledged, a term excluding set-off rights is common in postponement and non-disturbance agreements favourable to mortgagees. The annotation by Lem and Singerman points out that, typically, a mortgagee will seek to protect itself by requesting an estoppel certificate from the tenant, establishing the state of accounts between the Landlord and tenant at a particular time, and by negotiating an appropriately worded postponement and non-disturbance agreement, exempting it from responsibility for the tenant’s state of accounts with the Landlord. Indeed, the annotators comment that “a canvassing of the non-disturbance agreements currently in use across a broad base of the commercial lending spectrum will disclose an almost universal inclusion of at least some sort of provision expressly excluding set-off as an equity that must be honoured by the assignee”. See also J. Lem, “Subordination and Attornment” in H. M. Haber, ed., Tenants Rights and Remedies in a Commercial Lease (Aurora, ON: Canada Law Book, 1998) 357; and H. M. Haber, The Commercial Lease, 4th ed. (Aurora, ON: Canada Law Book, 2004), Article 15.
58Here, the Mortgagee neither requested an estoppel certificate from TDL nor excluded set-off rights in the PNDA. Indeed, the Mortgagee agreed to a postponement and non-disturbance agreement that was weighted heavily in favour of the tenant. Commercial practice does not automatically translate into legal rights and obligations, but it does give some practical comfort to my interpretation of the PNDA. I turn now to the Mortgagee’s remaining arguments.
c. Interpreting the PNDA to produce a sensible commercial result
59As I have said, the basic goal of contract interpretation is to determine the parties’ intent from the words that they used. In Consolidated-Bathurst Export Ltd. v. Mutual Boiler and Machinery Insurance Co., [1980] 1 S.C.R. 888 at 901, Estey J. elaborated on this basic goal. In doing so, he made the important point that courts should strive to interpret a contract in a way that produces a sensible commercial result:
Consequently, literal meaning should not be applied where to do so would bring about an unrealistic result or a result which would not be contemplated in the commercial atmosphere in which the insurance was contracted. Where words may bear two constructions, the more reasonable one, that which produces a fair result, must certainly be taken as the interpretation which would promote the intention of the parties. Similarly, an interpretation which defeats the intentions of the parties and their objective in entering into the commercial transaction in the first place should be discarded in favour of an interpretation … which promotes a sensible commercial result.
60The Mortgagee relied on Estey J.’s discussion of contract interpretation. It argued that interpreting the PNDA to give effect to TDL’s position would not yield either a fair or a sensible commercial result. I do not accept this argument.
61When the Mortgagee and TDL signed the PNDA, there was no hint of any dispute between TDL and the Landlord. The PNDA was signed in November 1999; the Landlord improperly posted the termination notice, which led to the breach of the Lease six months later, in April 2000. TDL likely insisted on using its own form of postponement and non-disturbance agreement. And the Mortgagee, either because it acceded to TDL’s stronger bargaining position or because it didn’t care at the time, signed TDL’s form of agreement. In this context, I am not persuaded that the large set-off award, undoubtedly unanticipated by TDL as much as by the Mortgagee, turns my interpretation of the PNDA into one that is not commercially fair or sensible. I accept that my interpretation threatens to deprive the Mortgagee of much, if not all, of the benefit of the Lease. But I do not think that the court’s role is to relieve a relatively sophisticated party from the consequences of what turned out to be a bad bargain.
62Moreover, the principle from Consolidated-Bathurst, supra on which the Mortgagee relies, depends on the existence of two plausible interpretations of the PNDA. I am not persuaded that the Mortgagee’s interpretation is plausible. Tenants and mortgagees routinely enter into postponement and non-disturbance agreements. In doing so, they have to allocate the risk of a defaulting landlord/mortgagor. In this case, the Mortgagee must have been aware of that risk because in taking an assignment of rents from the Landlord, it insisted on a covenant from the Landlord to perform its obligations under the Lease. In the PNDA, however, the Mortgagee agreed to exclude only the risk of prepayment of rent. Effectively, it agreed to assume all other risks. In this sense, the result in this case is not commercially unfair, but rather, it is consistent with the risk the Mortgagee agreed to bear.
d. Ambiguity and contra proferentum
63In interpreting a contract, courts have used a variety of techniques to avoid injustice. One technique is to use the principle of contra proferentum. Where the meaning of a contract provision is ambiguous or uncertain, a court will construe the provision against the party who drafted it. See Consolidated-Bathurst, supra at 900; and Eli Lilly, supra at para. 53.
64The Mortgagee urged us to apply contra proferentum to the interpretation of the PNDA. It submitted that whether the PNDA permits TDL to exercise its right of set-off against the Mortgagee is uncertain, and, as TDL drew the document, it should be interpreted contrary to TDL’s interests. I do not accept this submission.
65Although TDL used its standard form postponement and non-disturbance agreement, and the Mortgagee signed this standard form, I doubt that contra proferentum could play any role in interpreting the PNDA. This was a straightforward commercial transaction; both sides were represented by experienced, commercial lawyers; and though TDL likely had more bargaining power, we have no evidence that the Mortgagee was powerless to negotiate changes to the PNDA.
66However, the main reason why contra proferentum can play no role in interpreting the PNDA is that the meaning of the agreement is not ambiguous or uncertain. For the reasons that I have already given, I do not think that TDL’s right to assert its court-ordered set-off against rent payable to the Mortgagee is in doubt. I would therefore not give effect to the Mortgagee’s argument on contra proferentum.
Second Issue: Is TDL’s judgment against the Landlord binding on the Mortgagee?
67The motion judge held that even if he was wrong in his conclusion that the PNDA created a “clean slate” between TDL and the Mortgagee, nonetheless the Mortgagee was not bound by the judgment of Blenus Wright J. He gave these reasons for his holding: the Mortgagee was not a party to the litigation before Blenus Wright J; the Mortgagee was not given timely notice of that litigation; and the terms of the Lease did not give TDL a right of set off for the Landlord’ s breach of its covenant to indemnify TDL under s. 6.06 of the Lease.
68In holding that the Mortgagee was not bound by Blenus Wright J.’s judgment, the motion judge, understandably, was concerned about the size of the judgment, especially the costs component, and therefore about the amount TDL sought to set off against its rent. The motion judge also expressed concern about Blenus Wright J.’s analysis, especially about how he reached the conclusion that set off should be permitted.
69Although I am sympathetic to the motion judge’s reluctance to fix the Mortgagee with the responsibility for paying the judgment against the Landlord, I do not agree with his analysis. I do not think that the Mortgagee had to be a party to or have notice of the litigation before Blenus Wright J. to be fixed with responsibility for the outcome of that litigation.
70The litigation by itself did not affect the Mortgagee and would not have affected the Mortgagee but for its separate agreement with TDL. In other words, the Mortgagee’s responsibility for the judgment of Blenus Wright J. depended solely on the terms of the PNDA. It either agreed or did not agree to assume responsibility for the existing state of accounts between TDL and the Landlord if it went into possession. If, as I have concluded, the PNDA bound the Mortgagee to accept the state of accounts between the Landlord and TDL (other than any prepayment of rent), the Mortgagee must assume responsibility for the set off; if the PNDA did not so bind the Mortgagee, it would have had no responsibility for the set off. The situation might be different if TDL’s judgment was obtained by fraud but that obviously is not the case here.
71TDL’s action against the Landlord arose from a landlord-tenant dispute between them. I do not see why, as a matter of law or policy, a mortgagee should be encouraged to intervene in a landlord-tenant dispute. Nor do I think that the law should encourage what amounts to a reconsideration of the judgment in that dispute. I will say, however, that TDL was unquestionably entitled in equity to set off its damages award against rent, as Blenus Wright J. found. See Manufacturers Life Insurance Co. v. First brook, Cassie & Anderson Ltd. (1999), 5 R.P.R 4th 241 (Ont. Sup. Ct.). The amount of the substantial indemnity costs award, though large, was arrived at after an assessment that has not been impeached. And the judgment of Blenus Wright J. was affirmed in all respects by this court.
72TDL also argued that the Mortgagee was bound by the litigation before Blenus Wright J. as a party in privity of interest who had adequate notice of that litigation. In short, TDL submitted that issue estoppel applies. See Banque Nationale de Paris (Canada) v. Canadian Imperial Bank of Commerce (2001), 52 O.R. (3d) 161 (C.A.). This submission has merit. As landlord, the Mortgagee had privity of interest with the Landlord. TDL made the Mortgagee aware of its litigation against the Landlord in a letter sent nearly two years before the action was tried. Although the letter did not detail the nature of the litigation, it might have triggered an inquiry from a prudent potential landlord. The Mortgagee, however, made no inquiries. Even after it became fully aware of the trial judgment of Blenus Wright J., the Mortgagee took no steps to intervene in the Landlord’s appeal.
73However, I do not think that I need to decide whether issue estoppel is an alternative basis to hold the Mortgagee bound by TDL’s right of set-off. My main point is that the PNDA alone determines the Mortgagee’s obligations. And under the PNDA, the Mortgagee must assume the burden of TDL’s court-ordered right of set-off. I would not give effect to this ground of appeal.
Which of Two Innocent Parties Must Suffer?
74My proposed disposition of this appeal undoubtedly seems harsh. The Mortgagee bears no responsibility for the wrongs done by the Landlord to TDL. It could not have anticipated that those wrongs would result in a judgment of over $700,000. Giving effect to TDL’s right to set-off this judgment against rent may mean that the Mortgagee is deprived of rent for the entire balance of the Lease. Moreover, in this case, rather atypically, the tenant, not the Mortgagee, has the financial clout and leverage. The Mortgagee is not an institutional lender. TDL is the franchisor of Canada’s largest coffee chain. It is thus not hard to sympathize with the predicament of this entirely innocent Mortgagee.
75But TDL is also an innocent party. It too could not have anticipated that the Landlord would act so irresponsibly. And, as Blenus Wright J. concluded, requiring TDL to pay rent before setting off its judgment would be unconscionable.
76Thus, whatever the court’s disposition, one of two innocent parties will suffer. The PNDA says that the Mortgagee must suffer. The law of assignment says that absent an agreement to the contrary, the assignee must suffer. At least in this case the contract and the law correspond with the reality that the Mortgagee could have protected itself.
77The Mortgagee must be taken to have known that the Landlord’s actions could potentially impair its ability to collect rent. The Mortgagee could have asked TDL for an estoppel certificate, which would have set out the state of accounts between TDL and the Landlord. It could have protected itself by a properly worded postponement and non-disturbance agreement. It could have asked TDL about the nature of the dispute with the Landlord. The Mortgagee did none of these things. Unfortunately for it, the Mortgagee must live with the consequences of its failure to do so.
D. CONCLUSION
78Under the PNDA, apart from the prepayment of rent, the Mortagee is bound by the state of accounts between the Landlord and TDL, including TDL’s court-ordered right of set off. I would, therefore, allow the appeal and set aside the judgment of the motion judge. In its place, I would grant judgment declaring that:
a. TDL is entitled to set off against rent and other money due to the Mortgagee the amount awarded to it in the judgment of Blenus Wright J. dated March 19, 2003.
b. TDL is entitled to remain in possession of the leased premises in accordance with the terms of the PNDA.
79TDL is entitled to its costs of the motion and of the appeal. I would order that the costs of the motion be assessed. I would fix the costs of the appeal at $15,000 inclusive of disbursements and GST.
RELEASED: JUL 27 2006
JL
“John Laskin, J.A.”
“I agree M. Rosenberg, J.A.”
“I agree HS LaForme, J.A.”
Footnotes
- In February 2000, TDL and the Mortgagee signed and registered a Lease Recognition and Non-Disturbance Agreement. This agreement did not alter the relationship between the parties established by the PNDA, but was required by the Land Registry Office.
- For statutory assignments, the rule is codified in s. 53(1) of the Conveyancing and Law of Property Act, R.S.O. 1990 c. C-34.
