Majdpour et al. v. M & B Acquisition Corp. et al.

[Indexed as: Majdpour v. M & B Acquisition Corp.]

56 O.R. (3d) 481

[2001] O.J. No. 4932

Docket No. C36197

Court of Appeal for Ontario

Charron, Goudge and MacPherson JJ.A.

November 26, 2001

Bankruptcy -- Tenant granting sublease -- Landlord not consenting in writing to sublease -- Tenant making assignment into bankruptcy -- Subtenant relying on s. 39(2) of Commercial Tenancies Act to enter into direct lease with landlord -- Subsection 39(2) available where landlord by conduct approves sublease -- Landlord may waive s. 39(2) to enter into direct lease with subtenant -- Commercial Tenancies Act, R.S.O. 1990, c. L.7, s. 39(2).

Landlord and Tenant -- Tenant granting sublease -- Landlord not consenting in writing to sublease -- Tenant making assignment into bankruptcy -- Subtenant relying on s. 39(2) of Commercial Tenancies Act to enter into direct lease with landlord -- Subsection 39(2) available where landlord by conduct approves sublease -- Landlord may waive s. 39(2) to enter into direct lease with subtenant -- Commercial Tenancies Act, R.S.O. 1990, c. L.7, s. 39(2).

The respondents were franchisees operating shoe repair businesses. They each had signed a comprehensive franchise agreement and a sublease for the location of their businesses, usually a major shopping centre. On July 11, 2000, their franchisors declared bankruptcy, and the franchisors' assets were purchased by the appellant, M & B Acquisition Corp. ("M & B").

Relying on s. 39(2) of the Commercial Tenancies Act ("CTA"), under which a subtenant may become a direct tenant of the landlord where, before its bankruptcy, the tenant made a sublease "approved or consented to in writing by the landlord," the franchisees elected to became direct tenants of their respective business premises. M & B, however, disputed that s. 39(2) of the CTA applied because the landlords had never approved or consented to the subleases "in writing".

The franchisees brought proceeding by way of application to clarify their rights, and they alleged that the franchise agreements were null and void because of the franchisors' fundamental breaches of the agreements. The franchisees also sought a declaration that by operation of s. 39(2) of the CTA, they were each entitled to assume a direct tenancy with their respective landlords. Lederman J. held that s. 39(2) of the CTA applied but that there had been no fundamental breach. M & B appealed, and the franchisees cross-appealed.

Held, the appeal and the cross-appeal should be dismissed.

The key question on M & B's appeal was whether in s. 39(2) of the CTA, the words "in writing" in the phrase "approved or consented to in writing" modify both "approved or consented to" or only "consented to." The latter interpretation was the correct one. The alternative interpretation would render the word "approved" meaningless and would be inconsistent with the purpose of the provision, which is to protect subtenants. Further, a landlord may indicate its approval of a sublease without doing so in writing, and s. 39(2) would be available in those circumstances. In the immediate case, the landlords, which were sophisticated shopping centre owners, had, by their conduct, impliedly consented to the subleases. Moreover, the landlords, by not having appeared on the application, could be taken to have waived the benefit of the statutory protection provided to them by s. 39(2) of the CTA. Lastly, it would be unconscionable to allow M & B to challenge the absence of a consent in writing when t he obligation had been on the franchisor to obtain that consent. Accordingly, the appeal should be dismissed.

The cross-appeal should also be dismissed. Lederman J. had been correct in concluding that there had been no fundamental breach. It is very difficult to establish a fundamental breach, that is, that a party has been deprived of substantially the whole benefit of the contract. No breach of this nature occurred in this case. Alternatively, Lederman J. had been correct in concluding that the franchise agreement contained a specific provision dealing with breaches of material terms and that the franchisees were required to follow this provision if they wished relief from a breach. The provision in the lease militated against a finding of a fundamental breach.

APPEAL and CROSS-APPEAL of orders to declare the rights of subtenants under s. 39(2) of the Commercial Tenancies Act, R.S.O. 1990, c. L.7.

Cases referred to Hunter Engineering Co. v. Syncrude Canada Ltd., 1989 CanLII 129 (SCC), [1989] 1 S.C.R. 426, 35 B.C.L.R. (2d) 145, 57 D.L.R. (4th) 321, 92 N.R. 1, [1989] 3 W.W.R. 385 (sub nom. Syncrude Canada Ltd. v. Hunter Engineering Co.); J.Y.L., Re, [1951] O.J. No. 52 (H.C.J.); Schulte-United Ltd., Re, 1934 CanLII 116 (ON CA), [1934] O.R. 453, [1934] 4 D.L.R. 51, 15 C.B.R. 520 (C.A.) [Leave to appeal to S.C.C. refused, 1934 CanLII 329 (SCC), [1934] 4 D.L.R. 252, 15 C.B.R. 533] Statutes referred to Commercial Tenancies Act, R.S.O. 1990, c. L.7, s. 39(2) Landlord and Tenant Act, R.S.O. 1927, c. 190, s. 38(2) Rules and regulations referred to Rules of Civil Procedure, R.R.O. 1990, Reg. 194, rule 14.05 Authorities referred to Haber, H.M., Q.C., ed., Tenant's Rights and Remedies in a Commercial Lease: A Practical Guide (Aurora, Ont.: Canada Law Book, 1998) Haber, H.M., Q.C., Landlord's Rights and Remedies in a Commercial Lease: A Practical Guide (Aurora, Ont.: Canada Law Book, 1996) Langan, P. St. J., Maxwell on the Interpretation of Statutes, 12th ed. (London: Sweet & Maxwell, 1969)

David Sterns, for respondents in appeal/appellants by cross- appeal. Mervyn D. Abramowitz, for appellant in appeal/respondent by cross-appeal.

The judgment of the court was delivered by

MACPHERSON J.A.:

A. Introduction

[1] This appeal presents legal issues in two domains -- statutory interpretation and contract law. These legal issues arise in the context of two significant components of the Ontario business community -- commercial leasing and franchising.

B. Facts

(1) The parties and the events

[2] M & B Acquisition Corp. ("M & B") is a company which purchased the assets of Moneysworth & Best Shoe Care Inc. and Moneysworth & Best Shoe Repair (Canada) Inc. ("the franchisor") after these two companies declared bankruptcy on July 11, 2000. Before the bankruptcy, the franchisor had operated a shoe care and repair franchise system in many locations in Ontario.

[3] Amir Majdpour, Mershad Khalaj, Peyman Faghihi, 1417179 Ontario Limited, Shariar Ghasemi, Mehrdad Tavakoli-Malayeri and Yadollah Ahmadi ("the franchisees") are each owners of a franchise. They have owned their respective franchises for several years. Each franchisee executed a comprehensive franchise agreement and a sublease in respect of the location where the franchise operated, usually a major shopping centre.

[4] After the franchisor went bankrupt in July 2000, the franchisees decided to take over the leases to their locations and negotiate leases directly with the landlords, the shopping centre owners. In pursuing this plan, they purported to rely on s. 39(2) of the Commercial Tenancies Act, R.S.O. 1990, c. L.7 ("CTA") which provides:

39(2) Rights of sub-tenants -- Where the assignor, or person or firm against whom a receiving order has been made in bankruptcy, or a winding up order has been made, being a lessee, has, before the making of the assignment or such order demised any premises by way of under-lease, approved or consented to in writing by the landlord, and the assignee, liquidator or trustee surrenders, disclaims or elects to assign the lease, the under-lessee, if the under-lessee so elects in writing within three months of such assignment or order, stands in the same position with the landlord as though the under-lessee were a direct lessee from the landlord but subject, except as to rental payable, to the same liabilities and obligations as the assignor, bankrupt or insolvent company was subject to under the lease at the date of the assignment or order, but the under-lessee shall in such event be required to covenant to pay to the landlord a rental not less than that payable by the under-lessee to the de btor, and if such last mentioned rental was greater than that payable by the debtor to the said landlord, the under- lessee shall be required to covenant to pay to the landlord the like greater rental.

(Emphasis added)

[5] The italicized words proved contentious. M & B, which had purchased the franchisor's assets from the trustee in bankruptcy, wanted to maintain the original franchise agreements and subleases. It took the position that the franchisees could not disclaim the subleases and enter into direct leases with the shopping centre owners because the shopping centre owners had never "approved or consented to in writing" the subleases. [See Note 1 at end of document] Thus the condition precedent for the invocation of s. 39(2) by the franchisees was missing.

[6] The franchisees did not accept M & B's interpretation of s. 39(2) of the CTA. They brought an application pursuant to rule 14.05 of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194, to clarify their rights with respect to their subleases and, more broadly, to ascertain whether their obligations under the franchise agreements continued with M&B, the new franchisor.

(2) The litigation

[7] The franchisees sought two declarations: (1) a declaration that the franchise agreements were null and void by reason of fundamental breach or frustration of contract; and (2) a declaration that by operation of s. 39(2) of the CTA they were each entitled to assume a direct tenancy with their respective landlords.

[8] The application judge, Lederman J., dismissed the component of the application based on an alleged fundamental breach or frustration of the contract. He held that although there were defects and defaults in the franchisor's performance of its obligations, they did not rise to the level of fundamental breach. Moreover, he held that the franchise agreement contained a specific provision dealing with breaches of material terms and that the franchisees were required to follow the process set out in that provision before seeking relief in the courts.

[9] Lederman J. made the declaration sought by the franchisees relating to their subleases. He held that approval within s. 39(2) "is wider than written consent and approval need not be in writing" and that the head landlords by their conduct had impliedly consented to the subleases and thereby approved the franchisees as subtenants. Alternatively, he held that if s. 39(2) of the CTA required approval or consent in writing by the landlords, the landlords by their conduct had waived this statutory condition which was for their benefit.

[10] M & B appeals from the application judge's decision relating to the interpretation of s. 39(2) of the CTA. The franchisees cross-appeal from the application judge's decision relating to breach of contract.

C. Issues

[11] The issues on the appeal and the cross-appeal are:

Appeal

(1) Did the application judge err in his interpretation and application of s. 39(2) of the Commercial Tenancies Act?

Cross-Appeal

(2) Did the application judge err by concluding that the franchisor's conduct did not amount to a fundamental breach of the franchise agreement?

D. Analysis

(1) M & B's appeal

[12] I begin with a word about terminology. Since in this section of these reasons I will be considering s. 39(2) of the CTA, I will call the shopping centre owners "landlords", the franchisor M & B "the tenant" and the franchisees "the subtenants".

[13] The key question on M & B's appeal is whether the words "in writing" in the phrase "approved or consented to in writing" modify both "approved or consented to" or only "consented to". Put another way, if a landlord has not consented in writing to the sublease with respect to its premises, is it nevertheless possible for the landlord, through its conduct, to approve of the sublease, thus permitting the subtenant to invoke s. 39(2)? The application judge held that the words "in writing" modified only consent and that it was open for a landlord to give an approval to a sublease that "need not be in writing". I agree with the application judge's interpretation, for several reasons.

[14] First, if the words "in writing" modified the entire phrase "approved or consented to in writing", it would render the word "approved" meaningless. Such an interpretation would be contrary to the "presumption that a change of wording denotes a change in meaning": see Maxwell on The Interpretation of Statutes, 12th ed. (London: Sweet & Maxwell, 1969), at p. 282.

[15] Second, the main purpose of s. 39(2) of the CTA is to protect subtenants. In a franchise context, the bankruptcy of the franchisor puts its franchisees in a very vulnerable position. In Tenant's Rights and Remedies in a Commercial Lease: A Practical Guide, Harvey M. Haber, Q.C., ed. (Aurora, Ont.: Canada Law Book, 1998), Edward Levitt, the author of the chapter titled "Franchising", states, at pp. 55-56:

One of the most catastrophic events for a franchisee is the bankruptcy of the franchisor. This sets a sequence of events in motion, which can end in the failure of the franchisee's business as well or other less severe, but equally unsatisfactory results . . . Upon the bankruptcy of a franchisor, the franchisee must definitely shift into survival mode.

[16] In my view, in addition to protecting landlords, s. 39(2) is intended to assist the subtenant in a situation where the tenant becomes bankrupt. Given that purpose, as between two possible interpretations of the key words in s. 39(2), one of which assists the subtenant to maintain its lease in difficult times and the other of which would prevent the same result, I have no hesitation adopting the first interpretation. The purpose of s. 39(2) is best served by not requiring the subtenant to produce a document in writing from the landlord in every case in order to succeed.

[17] Third, I agree with the analysis of s. 39(2) of the CTA by Harvey M. Haber, Q.C. in his text Landlord's Rights and Remedies in a Commercial Lease: A Practical Guide (Aurora, Ont.: Canada Law Book, 1996), at p. 147:

A subtenant only acquires the rights afforded by s. 39(2) of the Act if the sublease was "approved or consented to in writing by the landlord". But written consent is not necessarily a prerequisite to a subtenant's rights under s. 39(2). Specifically, if the lease permits a sublease without the landlord's consent, or if the landlord, by its conduct, implied consent to the sublease, a court would likely find for the subtenant and consider the sublease to have been "approved" and that such approval need not be in writing.

[18] M & B's principal argument against the application judge's interpretation of s. 39(2) is that it is inconsistent with Re Schulte-United Ltd., 1934 CanLII 116 (ON CA), [1934] O.R. 453, [1934] 4 D.L.R. 51 (C.A.), leave to appeal refused, 1934 CanLII 329 (SCC), [1934] 4 D.L.R. 252, 15 C.B.R. 533 (S.C.C.) ("Schulte-United"). In that case, Schulte- United Limited ("Schulte") obtained a ten-year lease from United Cigar Stores Limited ("UCS") for retail store premises in Toronto. Schulte later assigned the benefits of that lease to Louis K. Liggett Company Limited ("Liggett"). Prior to the commencement of the term of the occupation by Liggett, Schulte was adjudged bankrupt and a trustee was appointed. The trustee abandoned the head lease with UCS, notifying Liggett of its actions. Liggett did not attempt to invoke s. 38(2) of the Landlord and Tenant Act, R.S.O. 1927, c. 190 (now s. 39(2) of the CTA); rather, it filed a claim for damages with the trustee for failing to be put in possession of the premises under the terms of the agreement with Schulte.

[19] In the course of discussing the damages issue, Davis J.A. of the Court of Appeal said, at p. 459 O.R.:

The appellant, not having secured the approval or consent in writing of the head lessor to its sub-lease, could not take the benefit of the provisions of sec. 38 of The Landlord and Tenant Act which protect the rights of sub-tenants where a sub-lease has been consented to or approved by the head lessor in writing.

I acknowledge that this passage, because of its use of "approval or consent in writing" at the start and the inverted use "consented to or approved . . . in writing" near the end, supports M & B's interpretation of s. 39(2) of the CTA.

[20] In the Supreme Court of Canada, a single judge, Rinfret J., was faced with the question of whether to grant leave to appeal from the decision of the Ontario Court of Appeal on the damages issue. He refused leave and said, at pp. 254-55 D.L.R.:

In this instance, the assignment or the underlease has not been "approved or consented to in writing by the landlord," the United Cigar Stores Ltd. Such approval or consent by the landlord is an essential requirement for the application of s-s. 2 of s. 38 of the Landlord and Tenant Act. The question is not, therefore, whether the Liggett Co. ought to have taken advantage of s. 38(2) and whether, having failed to do so, it is thereby deprived of the right to rank for damages against the bankrupt estate of the debtor. The question as it presents itself really is that s. 38(2) of the Landlord and Tenant Act has no application here. Under those circumstances, the point can hardly be found sufficient to warrant the granting of a special leave to appeal.

[21] I do not think that this passage assists the appellant. Rinfret J. merely set out, but did not interpret, the meaning of the words "approved or consented to in writing" because there was no issue relating to the landlord's approval -- in any form -- of the sublease. That is because the subtenant quit the leased premises as soon as the trustee disclaimed the head tenant's lease. The subtenant claimed its damages in the head tenant's bankruptcy rather than seek declaratory relief as the subtenants have done in the present case.

[22] In summary, the interpretation of s. 39(2) was not in issue in Schulte-United. Rinfret J. in the Supreme Court of Canada said nothing about its interpretation. Davis J.A. in the Court of Appeal made a brief reference in a single sentence that suggests that he regarded the words "in writing" as a modifier for both "approved" and "consented to". However, in my view, this brief obiter reference is not sufficient to overcome the three reasons I have set out in support of the application judge's interpretation of the provision.

[23] If, as I have determined, it is possible for a landlord to indicate its approval of a sublease in an unwritten form, the question becomes: have the various landlords done so in this case? The applications judge held that "the head landlords, by their conduct have impliedly consented to the subleases and the subtenants have thereby been approved."

[24] I agree with this conclusion. The various landlords are all large and sophisticated shopping centre owners. There can be no doubt they would know the identity of every business in their locations. The affidavit evidence of the subtenants establishes that they had regular contact with the landlords. Moreover, the landlords were given formal notice of these proceedings; none appeared to take issue with the relief sought by the subtenants. Accordingly, it is obvious that the landlords approved of the franchisees as subtenants before the franchisor's bankruptcy; moreover, the landlords' approval appears to be a continuing one.

[25] The application judge provided an alternative basis for making the declaration sought by the franchisee subtenants:

Moreover, the benefit of the statutory provision is for the head landlords and for the sublessees. The head landlords have not appeared on this application and take no issue with any lack of approval or consent in writing. Parties may waive a statutory condition introduced for their benefit and thus, the necessity for approval or consent in writing to the subleases by the head landlords may be deemed to have been waived by them. Accordingly, s. 39(2) applies in these circumstances.

[26] I agree with this analysis. The maxim quilibit potest renuntiare juri pro se introducto is explained in Maxwell on The Interpretation of Statutes, supra, at p. 328:

Everyone has a right to waive and to agree to waive the advantage of a law made solely for the benefit and protection of an individual in his private capacity, which may be dispensed with without infringing any public right or public policy.

See also: Re J.Y.L., [1951] O.J. No. 52 (H.C.J.).

[27] The intended beneficiaries of the requirement for approval or consent in s. 39(2) of the CTA are head landlords. Section 39(2) protects them against 'phantom' subtenants who might emerge on the bankruptcy of a tenant and assert the existence of a prior lease with the bankrupt tenant. In the present case, the knowledge and conduct of the landlords with respect to the subtenants indicate that they do not have a concern about them. Accordingly, in the circumstances of this case, the landlords can be deemed to have waived the statutory condition.

[28] I make one final observation on M & B's appeal. In addition to the reasons I have set out for agreeing with the application judge's interpretation of s. 39(2) of the CTA, I would state one further reason. In my view, it would be unconscionable to accede to M & B's argument on this issue. Article 3.2(a) of the franchise agreement imposed an obligation on the franchisor, acting as the franchisee's agent, to negotiate the terms of the lease with the landlord. From a franchisee's perspective, the landlord's approval or consent to the sublease pursuant to s. 39(2) would be particularly important. Accordingly, I would hold that the franchisor had a duty to ensure that the landlords formally approved of the subleases between the franchisor and the franchisees so that the franchisees would be in a position to invoke s. 39(2) of the CTA if the franchisor ever went bankrupt. The franchisor did not fulfil its important obligation in this case. In my view, its neglect in this regard disentitles it from attacking the subtenants' attempts to invoke s. 39(2) of the CTA.

[29] For these reasons, I would dismiss M & B's appeal.

(2) The franchisees' cross-appeal

[30] The franchisees sought a declaration that the franchise agreement was null and void because the franchisor, by its pre- bankruptcy conduct and by the act of bankruptcy, had fundamentally breached the agreement. The application judge refused to make the declaration on two bases: (1) although the conduct of the franchisor was deficient in several respects, the franchisees did receive essentially what they had bargained for; and (2) the franchise agreement itself had a specific process for dealing with breaches of material terms and termination of the agreement and the franchisees were required to abide by its terms. I agree with the application judge's analysis on both points.

[31] It is very difficult for a party to establish a fundamental breach of a contract. As Wilson J. explained in Hunter Engineering Co. v. Syncrude Canada Ltd., 1989 CanLII 129 (SCC), [1989] 1 S.C.R. 426 at p. 499, 57 D.L.R. (4th) 321 ("Hunter Engineering"), a fundamental breach occurs if the conduct of one party deprives the other party of "substantially the whole benefit" of the contract.

[32] The application judge held that the franchisees did receive essentially what they bargained for, including a shoe repair shop in a location of their liking, a lease, use of the M & B name, necessary fixtures, equipment, tools, inventory and supplies, and a training and support program.

[33] The franchisees assert that the application judge erred by considering only what they received at the time of purchasing their franchises; he failed to assess how the franchises actually operated.

[34] I disagree. After considering the evidence, the application judge concluded:

They were able to carry on their franchise business in this fashion both before and after the bankruptcy. Accordingly, the commercial purpose of the agreement was not destroyed, but carried on intact.

In short, the application judge considered both the commencement and the continued operation of the franchise agreement. In Hunter Engineering, Wilson J. described the deprivation of "substantially the whole benefit" of the contract definition of fundamental breach as "a restrictive definition and rightly so" (p. 499 S.C.R.). In my view, the application judge was correct in concluding that the franchisees had not demonstrated that the franchisor's conduct came within this restrictive definition.

[35] Turning to the second basis for the application judge's decision on the fundamental breach issue, article 12.1 of the franchise agreement requires a franchisee to give written notice to the franchisor of "breaches [of] a material term". The franchisor is then given 60 days to "commence reasonable steps to correct such breach". If the franchisee is not satisfied with the steps taken by the franchisor, it must deliver a notice of termination to the franchisor and the agreement would then terminate 30 days later.

[36] The franchisees did not invoke article 12.1 of the franchise agreement. In my view, the application judge was correct to conclude that "this militates against a finding that the alleged defaults constitute a fundamental breach entitling the applicants to terminate the franchise agreement".

[37] For these reasons, I would dismiss the cross-appeal.

E. Disposition

[38] I would dismiss the appeal and the cross-appeal, both with costs on a party and party basis, with one exception. I would award the franchisee Mehrdad Tavakoli-Malayeri his costs of the appeal on a solicitor and client basis.

Order accordingly.

Notes

Note 1: In fact, it now appears to be common ground that Hammerson Canada Inc., Omers Realty Management's predecessor, did provide a written consent to the sublease for the franchisee Mehrdad Tavakoli-Malayeri. As will be seen, this means that M & B's appeal against him must be automatically dismissed.