SUPERIOR COURT OF JUSTICE – ONTARIO
(COMMERCIAL LIST)
COURT FILE NO.: CV-10-8764-00CL
DATE: 20120427
APPLICATION UNDER RULE 14.05 (3)(d) and (h) of the Rules of Civil Procedure
RE: RIOCAN HOLDINGS INC., Applicant
AND:
METRO ONTARIO REAL ESTATE LIMITED, Respondent
BEFORE: MORAWETZ J.
COUNSEL:
Alexandra Lev-Farrell, for the Applicant
Adam J. Stephens, for the Respondent
ENDORSEMENT
OVERVIEW
[1] The issue to be determined is whether Metro Ontario Real Estate Limited (“Metro”) is required to pay RioCan Holdings Inc. (“RioCan”) its proportionate share of the $431,000 cost (the “Cost”) to rebuild the parking lot (the “Work”) at Dougall Plaza (the “Centre”), in Windsor, Ontario.
[2] Metro is an anchor tenant of RioCan at the plaza pursuant to a lease agreement entered into between their respective predecessors (the “Lease”). Section 25 of the Lease governs Metro’s obligations to pay its proportionate share of repairs and maintenance to the paved areas. It provides:
- Tenants’ Share of Services for Common Areas
The Tenant shall pay to the Landlord as additional rent, the Tenant’s proportionate share of the cost of the following services provided by the Landlord in respect of areas of the Centre common to the Tenant and the other Tenants in the Centre:
- Repairs to and maintenance of the sidewalks, paved areas, storm, sanitary, water, and utility services, directional signs and landscaping; […]
provided that the term “costs” within the meaning hereof shall mean and include only such sums as are actually and directly expended by the Landlord to provide the aforesaid services, and shall not include indirect or overhead expenses (except as aforesaid), nor expenditures which by accepted accounting practice are of a capital nature …
[emphasis added]
[3] In 2002, RioCan resurfaced the pavement of the parking lot at the Centre in order to correct some cracking and distress created by wear and tear from traffic and the elements. It then included Metro’s proportionate share of the Cost in additional rent charges, to be paid in annual instalments. From 2003 to 2006, Metro’s predecessor, and subsequently the Toronto Office of Metro, paid these charges without dispute. In 2007/2008, Metro asserted that the Work completed in 2002 was of a capital nature and that it should no longer be responsible for the Cost. Metro started to unilaterally apply a “credit” for 2007/2008 charges as against total rent in March 2010 and has continued this practice to date. RioCan responded by bringing this application under Rule 14.05, seeking payment of the amounts withheld by Metro and a determination that Metro should be responsible to continue to pay the Cost in accordance with the Lease.
[4] RioCan takes the position that its treatment of the Work as a “repair” was in accordance with “accepted accounting practice” in 2002, and questions whether Metro is entitled to revisit such treatment by RioCan, as well as its acceptance by Metro’s predecessors, several years after the fact.
[5] The Lease does not define “accepted accounting practice”. Metro asserts that the reference can only be to generally-accepted accounting principles (“GAAP”). RioCan agrees that GAAP is a source, but submits that it is also acceptable to look to tax accounting principles which are not inconsistent with GAAP, for guidance.
[6] The parking lot was “rehabilitated” in 2002 by a process that involved pulverizing the asphalt and underlying granular base, compacting it, and adding a new layer of hot mix. RioCan amortized the $431,000 Cost over 20 years and passed it on to the tenants.
[7] Both parties retained expert pavement and asphalt engineers who explained the nature of the Work and its consequences. The respective positions of the parties are detailed below.
[8] In addition, both parties retained expert accountants to explain whether the Cost ought to be capitalized in accordance with GAAP, or whether it is also acceptable to look to tax accounting principles which are not inconsistent with GAAP, for guidance. The position of the parties with respect to this issue is also detailed below.
FACTS
[9] RioCan rehabilitated the parking lot by use of a technology known as in-place pulverization (“IPP”), in order to address several areas with extensive cracking in the asphalt caused by wear and tear from vehicle traffic, the weather, and other conditions to which the pavement of a parking lot may normally be exposed.
[10] The general construction specifications for the Work show that the following tasks were completed as part of it:
(a) concrete curves were removed;
(b) all existing asphalt within the paved area of the parking lot was pulverized to a minimum depth of 250 mm;
(c) the pulverized asphalt was graded and new hot mix at 80 mm was placed on top;
(d) adjustments to 12 manholes and catch basins were made;
(e) concrete curves were replaced as needed.
[11] The Cost was apportioned over 20 years and billed to Metro (and other tenants of the Centre), pursuant to s. 25 of the Lease in monthly instalments of $3,837.07. Metro’s share of the instalments is $858.
[12] Metro acquired its predecessor under the Lease, A & P Canada, in August 2005. Metro paid its proportionate share of the Cost from 2003 to 2006, without dispute. The total amount paid was approximately $29,000. RioCan takes the position that Metro was fully aware of the particulars of the Cost and that the history of payments shows that they were not made automatically. Rather, questions were asked and answered before payments were made.
[13] The first objection raised by Metro was in 2007/2008 with respect to the 2007 reconciliations. Metro changed its position and decided to apply a credit for the instalments for 2007 and 2008 as a “set-off” against base rent for the month of March 2010 and onward. RioCan did not consent to the set-off and takes the position that there is no right of set-off contained in the Lease. The total set-off by Metro to date is approximately $17,000. The remaining amount owed for the Cost is approximately $36,000.
[14] The parties have divergent views as to the significance of the Work and, as well, with respect to the accepted accounting treatment of the Cost.
[15] To support its position, RioCan retained an engineering expert, Mr. Balasundaram, and an accounting expert, Mr. Gary Van Haren of PriceWaterhouseCoopers.
[16] To support its position, Metro retained an expert in pavement and asphalt engineering, Ms. Seddick, and an accounting expert, Ms. Paule Bouchard of RSM Richter Chamberland LLP.
POSITION OF RIOCAN
[17] In response to Metro’s position that “accepted accounting practice” in s. 25 of the Lease could only mean GAAP as set out in the Canadian Institute of Chartered Accountants (CICA) Handbook, RioCan’s accountants point out that tax accounting principles can also be used as a source to determine proper treatment of the Cost, to the extent that they are consistent with GAAP.
[18] GAAP encompasses broad principles and conventions of general application, from various sources, which set out general guidelines in accordance with which companies should prepare their financial statements.
[19] RioCan points out that the Lease does not have a specific reference to GAAP, even though GAAP was in existence in 1984 when the Lease was written. Both accountants agree that GAAP does not encompass tax accounting practices. However, RioCan’s accountant takes the position that tax accounting practices can be used, especially since the Lease uses the term “capital”. GAAP does not use the term “capital” but “betterment”; and “capital” is a term used in tax accounting.
[20] RioCan takes the position that, whether the analysis is under GAAP or consistent tax accounting practices, it was acceptable for RioCan to treat the Cost in 2002 as a repair as opposed to a capital expense and/or betterment.
[21] The terms of reference from the CICA Handbook and authoritative texts relied upon by both accountants provide that the determination of whether an expenditure should be treated as betterment or repair is based on whether or not the “service potential” of the asset at issue was “enhanced” by the expenditure (betterment) or just “maintained” (repair). RioCan is of the view that “service potential” means the expected future economic benefit to the owner from the expenditure.
[22] RioCan also takes the position that the ultimate analysis must focus on whether or not the expenditure will lead, directly or indirectly, to future net cash flows. For a landlord, this means an increase to rental income. By contrast, when an expenditure has the effect of a corrective action to restore an asset, or its component, to an operational condition, or maintain its service potential ( i.e. rental income) – it is properly considered a repair.
[23] RioCan’s accountant disputes the conclusion of Metro’s accountant that the lifespan of the parking lot pavement was “materially” extended by the Work and that this resulted in enhanced service potential of the parking lot. RioCan disputes this for the following reasons:
(i) enhanced service potential must relate to the asset at issue;
(ii) the parking lot is not an asset in this case, rather the asset is the Centre;
(iii) in any event, extension of the physical life of the pavement (which is neither an asset nor a component of an asset) does not equate to “enhanced service potential” of either the Centre or the parking lot because there was no future economic benefit to RioCan as a result of the Work. The rents required to be paid under the Lease were not changed, the entire Centre was fully leased at the time of the Work, and there is no expectation of increased rent as a result of it.
[24] RioCan emphasized that the parking lot does not generate its own revenues. Rather, it is there for the benefit of the tenants and their customers and the only benefit to RioCan is from the rents received from the tenants occupying the premises. Consequently, RioCan takes the position that the parking lot does not on its own meet the definition of “asset” under the CICA Handbook. At most, the parking lot is only a component of an asset.
[25] In addition, RioCan’s published accounting policy is to assign one estimated life to its shopping centres as a whole and not to assign a separate estimated life to any of its components ( e.g. roof, parking lot, etc.).
[26] With respect to RioCan’s engineering evidence, RioCan submits that pavements age and deteriorate with time due primarily to traffic. Techniques available to repair deteriorated pavement have changed significantly since the 1980s. A number of new methods have been developed, the majority of which recognize the value of recycling or reusing existing pavement materials. IPP is one of these methods. The asphalt is broken up so that the cracks in the existing asphalt do not reflect through and then the broken up asphalt is mixed and reused with the existing base.
[27] Metro’s engineer opined that the Work resulted in a superior asphalt layer and granular base to the one being based and, as a result, the lifespan of the pavement was extended by an estimated 15 – 18 years. RioCan’s engineer opined that it is impossible to say with any degree of confidence that the extended life of the pavement after IPP would be 15 – 18 years without carrying out a traffic analysis.
[28] RioCan also takes issue with the assertions of Metro’s engineer that within the paving industry, IPP is considered “major rehabilitation” and not a “repair”. RioCan points out that in making this assertion, Metro’s engineer relies on the Ministry of Transportation of Ontario’s (“MTO”) Pavement Design and Rehabilitation Manual. However, as pointed out by RioCan, the MTO Manual does not refer to IPP as “major rehabilitation” but as a relatively recent example of a method of “rehabilitation”. Furthermore, the MTO Manual uses the term “repair” synonymously and interchangeably with “rehabilitation” and even “maintenance”, and states that all such methods aim at preserving and extending pavement life.
[29] RioCan also provides a summary of the engineering evidence, submitting as follows:
(i) that “repair” and “rehabilitation” are interchangeable terms;
(ii) that any method of repair/rehabilitation and/or maintenance extends the life of pavement and that is precisely its purpose;
(iii) that there is no reliable evidence to support the assertion that the pavement, after the Work, will have an extended life of 15 – 18 years;
(iv) that although the life of the pavement was extended from its deteriorated state, it does not have the same service life as a new pavement; and it is not a different or improved pavement;
(v) that there is no increase to the life of either the parking lot or the Centre as a result of the Work.
[30] RioCan’s engineer also stated that RioCan had a few options in 2002 regarding how to restore the pavement to a serviceable condition and that all of these options would have resulted in higher costs for ongoing repair and/or maintenance, which RioCan points out would have been the responsibility of Metro and other tenants.
[31] RioCan also contends that it is necessary to consider whether the increase in pavement life results in future economic benefit to RioCan. RioCan contends that comparison must be made to the previously estimated life of the asset. If the asset’s estimated life has not increased as a result of the work, then it is a repair. In this case, RioCan contends that the asset’s (Centre including the parking lot) life was estimated to be 40 years starting in 1998 and ending in 2038. Even if the pavement’s life has been extended by approximately 15 years from 2002, as alleged by Metro’s engineer, this did not extend either the parking lot’s or Centre’s previously estimated life.
[32] In summary, RioCan’s position is that, for there to be a finding that the new asphalt layer was capital in nature, there must be a future economic benefit to RioCan by way of increased rental income, and it was incumbent upon Metro to actually identify how a new asphalt layer results in increased future rental income to RioCan. RioCan submits that its own accountant’s conclusion that there is no expectation of increased rental income to RioCan as a result of the new asphalt layer is consistent with RioCan’s published accounting policy; the engineering evidence; and the proper application of GAAP.
[33] RioCan’s position also takes into account guidance from tax accounting practices. RioCan submits that the Canada Revenue Agency considers the following factors in determining whether an expenditure is capital or repair: whether it results in enduring benefits; whether it serves to restore an asset to its original condition (which is a repair) or materially improve the asset beyond its original condition (which is capital); whether the work was done to an integral part of an asset or a separate asset.
[34] RioCan takes the position that the guidance in the Revenue Canada Interpretation Bulletin (IT-128R) also supports the accounting treatment of the Cost as a repair because: the Work generally restored the pavement asphalt to its original condition and did not result in any enduring benefit to RioCan; the Work was done to the parking lot pavement, which is an integral part of the Centre; and, the Centre was not materially improved.
POSITION OF METRO
[35] Ms. Seddick, the expert pavement and asphalt engineer on behalf of Metro, describes the impact of the Work:
The mixture of asphalt and underlying granular material are graded and compacted to form a new, superior foundation. The impact of the pulverization process is that the strength of the pavement structure is generally improved “over what existed prior to the rehabilitation”. This occurs because the resulted pulverized base granular material has similar strength of new granular material. This is replacing the existing granular material that had weakened over time. New hot mix is overlaid on top of the pulverized material. This new overlaid asphalt is much stronger than the asphalt it is replacing. Therefore, after the pulverization process is complete, there is a new, superior, granular base as well as a new, superior, hot mix layer.
[36] Any sub-surface cracks are eliminated by this rehabilitation process.
[37] Ms. Seddick went on to state that, within the paving engineering industry, this type of work is referred to as major rehabilitation. She stated:
Within the paving industry, in-place pulverization is considered major rehabilitation. It is not considered a repair. Repairs are typically considered minor, typically inexpensive solutions to localized problems. The main purpose of repairs is to maintain the pavement in its current state as a holding strategy as opposed to a solution that will greatly enhance the quality and lifespan of the parking lot….
Within the industry, the in-place pulverization that took place at Dougall Plaza is considered to be major rehabilitation that will extend the service life of the parking lot by 15 to 18 years and not a repair.
[38] Metro points out that Ms. Seddick estimated that the Work extended the life of the parking lot by 15 to 18 years, provided that routine maintenance (filling pot holes, etc.) is undertaken. This estimate was based on standard estimates within the pavement engineering industry. Metro argues that this estimate was later strengthened by Ms. Seddick’s analysis of auger probe logs, which permitted her to perform calculations designed to gauge pavement strength. Ms. Seddick concluded that the rehabilitated parking lot was, in fact, better than new.
[39] Metro also points out that Mr. Balasundaram did not disagree with Ms. Seddick’s estimate for the life expectancy for the pavement. He said that without a “structural analysis” or a “traffic report”, it is impossible to say with any degree of confidence that the parking lot will last between 15 and 18 years. Mr. Balasundaram used a different analysis than Ms. Seddick to test pavement strength but arrived at a similar conclusion. His preferred method was the American Association of State, Highway and Transportation Officials (“AASHTO”) method. The result of the application of the AASHTO method was that “the structural strength of the pavement immediately after repairs in 2002 was found to be close to, but not the same as that of the originally constructed pavement”. As such, Metro takes the position that Mr. Balasundaram conceded that, using the AASHTO method, the difference between the strength of the original pavement as compared to the rehabilitated pavement was not significant.
[40] In addition, Metro points out that the Work caused a significant reduction in the annual operating costs of the parking lot. Mr. Balasundaram estimated the costs of maintenance following the Work to be $183,836 over 20 years, as compared to $748,913 if no rehabilitation had taken place and the parking lot was maintained by only patching and crack sealing.
[41] With respect to Metro’s objections to the cost of the Work, it states that in 2008, as part of its review of its common area maintenance costs, Metro requested particulars of the Work being done to the parking lot. A request for information was made on December 9, 2008. In February 2009, RioCan provided Metro with the construction specifications and purchase order for the Work, documentation that had not previously been disclosed. In a letter dated February 11, 2009, Metro wrote to RioCan objecting to the charge.
[42] Metro contends that both experts agreed that GAAP was applicable to the question of whether “by accepted accounting practice” (the Work is) of a capital nature. Metro’s expert concluded, however, that “accepted accounting practice” referred exclusively to GAAP. This differs from RioCan’s expert who, as noted above, was of the opinion that additional sources may also be relevant as “accepted accounting practices”, provided that those sources are consistent with GAAP.
[43] GAAP is defined as encompassing “specific rules, practices and procedures relating to particular circumstances” as well as “broad principles and conventions of general application”. Section 100.59 of the CICA Handbook states: “Specifically, generally accepted accounting principles comprise the accounting recommendations in the Handbook and, when a matter is not covered by a recommendation, other accounting principles from a number of listed sources”. GAAP does not include tax accounting principles or practices.
[44] In her report, Ms. Bouchard states that “it is inappropriate to use tax practices to support an accounting treatment. This is due to the fact that tax law and practices are based on a completely different framework than generally accepted accounting principles”.
[45] Metro contends that there is agreement between the accounting experts that costs to better an item of property are capital costs. Metro also references the concept of service potential. In its submissions, Metro references the conclusion of Mr. Van Haren to the effect that the Work was not capital in nature as it was not a betterment. As noted above, in reaching this conclusion, Mr. Van Haren opines that for there to be an increase in service potential, one must be able to point to specific economic benefits that flow from the Work. Mr. Van Haren placed heavy emphasis on the fact that the parking lot was not a paid parking lot and that there was no evidence that rents to RioCan increased.
[46] Metro’s expert disagreed that there was a need for direct evidence of future net cash flows resulting from the Work in order for it to be considered a betterment. Ms. Bouchard points out:
All items or component parts of a leased property exist to yield economic benefits. The definition of asset [in CICA] makes this clear as it requires, to be an asset, an item must have the capacity, singly or in combination with other assets, to contribute directly or indirectly to future net cash flows of the entity. There is no debate that the parking lot at Dougall Plaza is an asset. It is a component of the overall property. When there is a significant increase in the useful life of an asset that is part of a leased property, there is also an increase in the useful life of the leased property and of its service potential. It is obvious there are economic benefits resulting from the work on the parking lot as it will last a significantly longer period of time than the deteriorated parking lot.
[47] Counsel to Metro submits that in determining whether the Work is capital in nature, it is not necessary – and indeed unheard of within the accounting industry – to engage in an exercise of trying to match particular revenues with the improved asset. The exercise is not done because there is no requirement of a direct relationship between the improved asset and revenue. An indirect relationship is sufficient.
[48] Metro further contends that RioCan’s internal accounting is not relevant to the proper classification of the Cost. As explained by Ms. Bouchard:
Accounting policies and decisions made based on materiality at the financial statements level of RioCan REIT, as a whole, which owns 176 properties…are not the same as the ones that would be determined at the financial statements level of one property, namely Dougall Plaza. That is the level at which the analysis should be done for the purpose of determining what is the proper accounting treatment of a cost incurred at a particular property where the determination will have an impact on a lessee.
[49] Metro contends that in the context of determining the rights of a tenant pursuant to a lease, it would be odd for the internal accounting policies or decisions of the landlord to be a relevant consideration. Otherwise, the tenant’s rights may change if the lease is assigned to a different landlord that had different internal accounting policies. In this case, RioCan was not the landlord and Metro was not the tenant when the Lease was entered into.
LAW AND ANALYSIS
[50] The issue to be determined, as stated at the outset, is whether Metro is required to pay RioCan its proportionate share of the Cost of the Work. From the standpoint of RioCan, the sub-issue is whether RioCan’s treatment of the Cost as a repair was in accordance with “accepted accounting practices”. Counsel to RioCan submits that this is not an issue that can be resolved by the mechanical application of GAAP because: the Lease does not refer to GAAP, and “accounting principles” may include both GAAP and tax accounting practices, to the extent they are not inconsistent. As such, counsel submits, there is no strict rule or rigid formula in GAAP mandating that pavement resurfacing by means of IPP be invariably treated as betterment. Rather, counsel submits the issue must be resolved by applying general rules of contractual construction and applicable accounting practices and principles to the facts of this case.
[51] Counsel to RioCan takes the position that the meaning of the phrases “expenditures which by accepted accounting practice are of a capital nature” and, more generally, “costs of a capital nature”, are not clearly defined in the case law and the determination is highly fact dependent.
[52] Most of the case law pertaining to whether a cost is “capital” is in the income tax context. While RioCan acknowledges that accounting principles and income tax principles are not the same, RioCan’s accountant states that there is some overlap in the principles, and the treatment of the Cost as repair is consistent with applicable tax accounting principles. Since both GAAP and tax accounting principles focus on the concept of benefit to the business, counsel to RioCan submits that tax cases provide some general guidance.
[53] Metro frames the issue somewhat differently. Counsel for Metro submits there are three questions to be determined:
(a) is the Work “repair or maintenance”?
(b) what meaning is to be given to “accepted accounting practice”?
(c) was the Work a betterment (capital) or repair under accepted accounting principles?
[54] This approach is based on the reading of s. 25 of the Lease which stipulates that Metro is responsible for its proportionate share of costs for “repairs and maintenance” of the paved areas. The first issue to be determined from the standpoint of counsel to Metro is whether the Work was “repair or maintenance”. This question, in Metro’s view, is separate from the question relating to the proper accounting treatment.
[55] In my view, it is difficult, if not impossible, to separate Metro’s first question from its second question. Both are relevant to the analysis. The Tenant is responsible for repairs to and maintenance of the paved areas, including the parking lot. However, to determine whether certain work qualifies as a repair or maintenance, it is necessary, in my view, to also consider the second question relating to “accepted accounting practices”. Indeed, it is the second question that informs the first: the meaning of “accepted accounting practice” must be determined before the Work can be classified as repair or maintenance.
[56] To me, it is significant that there is agreement between the accounting experts that accepted accounting principles must be consistent with GAAP. There is no issue, in my view, that GAAP principles are instructive. However, it also follows that the failure to specifically bind the parties to the application of GAAP principles means that income tax considerations are not necessarily excluded. However, given the agreement as between accounting experts that GAAP principles are instructive, it is useful, in my view, to first focus on the GAAP principles.
[57] Counsel to Metro referenced Concorde Centres Inc. v. Inland Plastics Limited [2003] S.J. No. 859. In Concorde, the issue to be determined was whether work done to a roof of an industrial building was a capital cost or a current cost that could be charged to tenants as occupancy costs. After attempting to repair a leaking roof, the landlord decided to remove the existing roof membrane, which consisted of replacing the old membrane with a new membrane and placing gravel on the roof. The existing roof material was removed and replaced with the same type of material. A new layer was added to protect the insulation from the heat of the asphalt when the roof membrane was applied. The lease language at issue provided that “occupancy costs” included:
6.b (iv) repairs and replacements to and maintenance of the building, including but not limited to the cost of maintenance and repair of the roof of the building, the surface of the exterior walls of the building so long as such repairs, replacement and maintenance are not normally charged to the capital account in accordance with accounting principles generally accepted in the Province of Saskatchewan. (See Concorde, supra, at para. 11)
[58] The court stated, at para. 12, that the applicable test to be applied was as follows:
The leases are specific that occupancy costs are to be determined by the GAAP principles. Both chartered accountants…, in their affidavits agreed that under GAAP principles an item is placed into the capital account if it can be considered a “betterment”. The [CICA] Handbook is the recognized authority on [GAAP] in Canada. Paragraph 3061.26 of the CICA Handbook… states:
The cost incurred to enhance the service potential of a capital asset is a betterment. Service potential may be enhanced when there is an increase in the previously assessed physical output or service capacity, associated operating costs are lowered, the life or useful life is extended, or the quality of the output is improved. The costs incurred in the maintenance of the service potential of the capital asset is a repair, not a betterment…
[59] At para. 16 in Concorde, the court concluded that the costs of the roof were capital costs, relying on the fact that the work extended the life of the building.
[60] Counsel to Metro also points out that in Concorde the court did not attempt to match certain revenues to the work on the roof. Counsel submits that in an income-producing property, the fact that replacing the roof yields economic benefits was seemingly taken as a given.
[61] However, in Concorde, the court commented that the question was to be determined based on the application of GAAP. In the present case, the specific application of GAAP is not referred to in the Lease. However, I note again that counsel to both parties agree that to the extent sources other than GAAP are to be consulted in determining this case, they must be consistent with GAAP.
[62] Counsel to Metro points out that the accounting experts in this case agree that the above referenced section of the CICA Handbook is applicable.
[63] Counsel to Metro also referenced 789247 Ontario Inc. v. 215 Piccadilly Properties Inc., 1992 CarswellOnt 4082, a decision of the Court of Appeal which considered whether the paving and lighting of a previously unlit and unpaved parking lot was properly considered “maintenance” and therefore chargeable to the tenant. The question was whether the work undertaken fell within the definition of “maintenance” such that the costs could be passed on to the tenant.
[64] In my view, this decision is not applicable to this case. In the present situation, the parties are dealing with a pre-existing paved parking lot which was the subject of rehabilitation. This is not comparable to the lighting and paving of a previously unlit and unpaved parking lot.
[65] Counsel to Metro also referenced Alderman Holdings Inc. v. McCutcheon Business Forms Inc., 1997 CarswellOnt 4345 (O.C.J. Gen. Div.), where the court considered whether the substantial replacement of a roof constituted “repairs” pursuant to the lease. The tenant’s position was that the work “was a replacement” or a “capital improvement”, neither of which were contemplated under the clause requiring additional rent for “repairs”. The court stated:
…I infer, in addition, that [the landlord] expected that the lease agreement, so far as it referred to additional rents or repairs, contemplated the type of repairs that were initially passed on and paid, but did not expect it to encompass the extent of roof work which the roofer characterized as a “replacement”. [The landlord] is merely trying to pass on to the tenants the cost of putting the building into better shape than it was when purchased. This is not the tenants’ responsibility under the lease.
[66] Counsel to Metro submits that the reasoning of Alderman is applicable here as the nature of the Work – the rehabilitation of the parking lot so that it was close to or better than new, at a cost of $431,000 – was not what the parties could have contemplated when considering the tenants’ obligation to compensate the Landlord for costs of repair and maintenance to the paved areas. Counsel submits that the rehabilitation resulted in a parking lot that would last as long as the original parking lot.
[67] As counsel to Metro points out, the Work caused the parking lot to be as “good as new”, or nearly as good as new, and significantly extended its life. The Work significantly decreased the operating costs of the parking lot from what they would have been without the rehabilitation.
[68] The significant extension of the parking lot’s life and the significant reduction of operating costs are factors referenced in the CICA Handbook for determining when the service potential of an item of property has been enhanced such that the work that enhanced the service potential should be considered a betterment.
[69] Importantly, counsel to Metro also emphasized that although RioCan amortized the Cost of the rehabilitation over 20 years – which itself suggests the Cost is a capital cost – there is nothing in the Lease that required it to do so. Thus, counsel to Metro points out that for RioCan to succeed on its application the court must conclude that, pursuant to the Lease, it was permitted to charge its tenants the entire $431,000 as a lump sum in 2002. Counsel also maintains that the Cost alone suggests that the Work was not repair or maintenance. I agree.
[70] RioCan emphasizes that there is some overlap in the accounting and tax principles, and the treatment of the Cost as a repair is consistent with applicable tax accounting principles. RioCan therefore emphasizes tax cases as being useful in providing general guidance.
[71] Tax cases have applied a range of tests, the most traditional of which was that, to be capital, the expenditure must be made with a view to bring an advantage for the “enduring benefit” of the business. Further, there must be a common sense appreciation of all the guiding features that will provide the ultimate answer, which depends on what the expenditure is calculated to effect from a practical and business sense.
[72] Counsel submits that tax case law directs that new advancements and techniques which give rise to new and better methods for repairing deteriorating properties should not by operation of law transform repairs into capital expenditures. Simply put, if there is a need to repair, the owner is not required to ignore advancements in technology in carrying out the work. See Gold Bar Developments Ltd v. Canada (1987), 1987 9490 (FC), 9 F.T.R. 303; Hare v. Canada, [2011] T.C.J. No. 221; and Lewin v. Canada, [2008] T.C.J. No. 472.
[73] In its factum, RioCan provides a summary of its position. Based on the facts and applicable accounting and legal principles, RioCan submits that it is entitled to charge the Cost as a repair under the Lease. According to RioCan:
(a) The relevant asset is the Centre, not the parking lot. The parking lot does not generate its own income. Its only purpose is to provide parking space for the customers of the tenants. It is consistent with GAAP principles applicable to the real estate industry, and RioCan’s consistent accounting practices, to treat the Centre, including the parking lot, as one asset;
(b) The engineering evidence relied upon by Metro in support of its assertion that the life of the parking lot was extended in fact alleges that the life of the pavement was extended. The evidence was undisputed that the pavement is only one component of the parking lot; that the Work only affected two of the four components of the pavement; and that it did not result in any expansion of or addition to the parking lot spaces or pavement area. In other words, prior to the Work, the pavement had visible cracks and distresses in some areas, and after the Work, it did not. Nothing else changed;
(c) In any event, it is undisputed that pavement is not an asset and, therefore, even if there is an extension in its physical life as a result of a new layer of asphalt, this does not mean that there is an extension in the life of the parking lot. In fact, there is no engineering evidence that the life of the parking lot was extended as a result of the alleged extended life of the pavement. Moreover, the physical life of the Centre was not extended;
(d) Therefore, the previously estimated life of the Centre (which includes the parking lot) was not extended as a result of the Work. This is indicative of repair;
(e) Most importantly, Metro could not point to any future economic benefit to RioCan as a result of the Work. Without such a benefit, there can be no enhanced service potential and therefore no betterment;
(f) The consideration of what constitutes a “repair” under GAAP and consistent tax principles is consistent with the interpretation of repair in the context of a commercial lease. Therefore, sealing cracks or putting in a new asphalt layer to address the cracks are both “repairs”; and
(g) The fact that Metro’s predecessors accepted the Cost for several years is “subsequent conduct” indicative of the parties’ intention that the Cost was properly chargeable as “repair” under the Lease and illustrates the parties’ agreement that the tenant was required to pay for the Cost. Metro should be bound by that agreement as a successor under the Lease and should not be entitled to “revisit” RioCan’s treatment of the Cost at this stage. In the alternative, Metro should be deemed to have waived any right to dispute the Cost. See Federal Business Development Bank v. Steinbock Development Corp. Ltd., [1983] A.J. No. 896 (C.A.).
[74] It seems to me that many of RioCan’s conclusions, drawing upon the facts as set out by RioCan and the accounting and legal principles it uses, are flawed.
[75] The dividing line between a capital expense/betterment and a repair/maintenance expense is not black and white. Indeed, it is decidedly grey. The relevant case law and the expert opinions proffered in this case are reflective of this.
[76] The expert evidence submitted by the parties was reasonably consistent. However, the accounting experts differed in their conclusions regarding whether the Work was a capital expense/betterment or a repair/maintenance expense. Their divergent viewpoints largely flow from their disagreement regarding whether the Centre, or the parking lot, should be considered the relevant asset.
[77] RioCan takes the position that the relevant asset is the Centre, not the parking lot. In my view, this submission is miscast. This dispute revolves around the rehabilitation of the parking lot and whether the cost of the project can be passed on to the tenants of the Centre.
[78] I can readily understand why RioCan wants the debate to focus on the asset as being the Centre. This approach supports its submission that the Work did not increase the economic life of the Centre. However, it seems to me that this is not a realistic or appropriate approach to analyze the issue. Rather, it seems to me that the more appropriate approach is to focus on the relevant component of the asset, namely, the parking lot.
[79] I do not disagree that, under GAAP and under RioCan’s accounting practices, the Centre, including the parking lot, can be treated as one asset. However, that is an internal matter to be determined by RioCan. The impact of such a decision is that of presentation on RioCan’s financial statements. It does not necessarily impact on the resolution of a contractual dispute as between RioCan and one of its tenants. In this regard, I agree with the submission of counsel to Metro that RioCan’s internal accounting is not relevant to the proper classification of the Cost. As Metro notes, RioCan’s financial statements are prepared at the level of RioCan REIT, and treat each of its 176 properties as a single asset.
[80] Further, at paragraph 29 of the RioCan factum, it acknowledges that, at best, the parking lot can be considered a component of the asset.
[81] Even if the parking lot is only a component of the asset, it seems to me that, for the purposes of this application, it is a most relevant and important component of the asset.
[82] The evidence submitted by the parties is not substantially different on the issue of the parking lot. By any description, the rehabilitation of the parking lot was a significant project. It was not simply fixing pot holes. It was not painting lines. It was, in my view, a significant capital project.
[83] The rehabilitation had the effect of reducing ongoing operating expenses. It also had the effect of extending the life of the parking lot such that, if properly maintained, it would last for 15 - 18 years. There is some disagreement between the experts as to whether the parking lot would last this length of time, but there is agreement that the rehabilitation would last for a considerable period of time.
[84] RioCan also focuses on the estimated life of the Centre and the fact that this was not extended as a result of the Work. If this argument is taken to its logical conclusion, there could never be a capital expenditure on the parking lot, as it would never extend the life of the Centre. Thus, even if the project involved a full demolition and rebuild of the parking lot, on RioCan’s argument, it would be a repair. This, in my view, defies logic.
[85] RioCan also submits that Metro could not point to any future economic benefit to RioCan as a result of the Work, and that without such benefit there can be no enhanced service potential and, therefore, no betterment. On this issue, both experts provided evidence.
[86] Mr. Van Haren, RioCan’s expert, emphasized that the parking lot was not a paid parking lot and there was no evidence that rents increased as a result of the Work.
[87] Metro took the position that there was no need for direct evidence of future net cash flows resulting from the Work in order for it to be capitalized. Ms. Bouchard stated that all items or component parts of a leased property exist to yield economic benefits. To support this position, she referenced CICA guidelines.
[88] Further, as counsel to Metro points out, Mr. Van Haren did not undertake any analysis of the impact of the Work on cash flows. He did not request evidence from RioCan pertaining to any impact the Work had on its collection of percentage rent, nor did he review any evidence of what the impact of the Work was on the number of visitors to the Centre. Further, he acknowledged that he included statements in his report about the economic consequences of the Work that were outside his expertise.
[89] The evidence submitted by RioCan on this specific point is, in my view, not helpful. It again attempts to shift the entire focus from the parking lot to the Centre.
[90] In my view, the better approach is the one taken by Ms. Bouchard that concludes that the parking lot is a component of the overall property and that, where there is a significant increase in the useful life of a component of the leased property, there is also an increase in the useful life of the leased property and of its service potential. Ms. Bouchard goes on to state that, “It is obvious there are economic benefits resulting from the Work on the parking lot as it will last a significantly longer period of time than the deteriorated parking lot”. I agree with this approach. Further, I also agree with her statement to the effect that, in determining whether the Work is capital in nature, it is not necessary to engage in an exercise of trying to match particular revenues with the improved asset. Indirect relationships are sufficient, examples of such relationships in respect of the Work are:
(a) complying with the landlord’s lease obligations and thereby avoiding claims by its tenants;
(b) retaining existing tenants;
(c) attracting new tenants;
(d) obtaining additional rent to the extent the landlord is entitled to rent as a percentage of the tenants’ sales and sales increase because of the quality of the property;
(e) enhancing the economic value of the property; and
(f) avoidance of possible claims from visitors to the property relating to injuries sustained in the parking lot.
[91] Further, as noted by counsel to Metro, in Concorde, supra, the court did not attempt to match certain revenues to the work on the roof. Rather, in an income producing property, the fact that replacing the roof yields economic benefits was seemingly taken as a given. This, in my view, reflects a common sense approach which, as noted by counsel to Metro, should also be applied in this case.
[92] The position of RioCan, detailed above at [73], has not persuaded me that the Cost of the Work can be charged as a repair. Indeed, it is noteworthy that RioCan amortized the Cost of the rehabilitation over 20 years – which itself suggests the cost is a capital cost – even though there is nothing in the Lease that required it to do so.
[93] As stated by counsel to Metro at paragraph 51 of its factum, “for RioCan to succeed in its Application, the court must conclude that pursuant to the Lease, it was permitted to charge its tenants the entire $431,000 in 2002. The Cost alone suggests that the Work is not repair nor maintenance”.
[94] I agree with this statement and conclusion.
[95] It seems to me that an inescapable conclusion, on the facts of this case, is that the Work performed on the parking lot went beyond a simple repair or patch job. In essence, the Work resulted in a complete rehabilitation of the parking lot. A significant expenditure was made with a view to correcting existing issues in order to significantly lower annual operating expenses and end up with a finished product that was as good, or nearly as good, as a brand new parking lot.
[96] I also agree with the submission of counsel to Metro that arguments based on whether the pavement is an asset or part of an asset, or whether the Work caused RioCan to increase its estimate for the useful life of the Centre as a whole, are overly technical and unhelpful. I also agree with counsel’s conclusion that the parties to the Lease would be expected to take a common sense approach to what is properly considered a capital expense pursuant to accepted accounting principles, and that such an approach could not involve the myriad of extremely technical considerations being advanced by RioCan.
DISPOSITION
[97] As the RioCan factum points out, the determination of “expenditures which by accepted accounting principles are of a capital nature” and more generally, “costs of a capital nature”, are not clearly defined in the case law and are highly fact dependent. In this case, I have determined that the parking lot is the relevant asset and that the Work performed was, in the context of s. 25 of the Lease, properly characterized as an expenditure which by accepted accounting practice is of a capital nature, and not a repair.
[98] The Cost of the Work is not to be charged to Metro as additional rent. The Cost is a capital expenditure.
[99] Insofar as there was no agreement that Metro would not dispute the payment of common area maintenance costs even if it had previously paid them, I accept Metro’s position. I do not see a principled basis upon which to preclude Metro from recovering the costs it already paid since the rental adjustments were implemented by RioCan. Simply put, the adjustments should not have been made and Metro is entitled to make the appropriate adjustments through set-off.
[100] The application is therefore denied and a declaration shall issue that Metro is entitled to set-off sums paid to the Applicant on account of the repairs as against rent due and owing under the Lease.
[101] Counsel have agreed that costs of $35,000 and disbursements of $55,000, both exclusive of HST, would be appropriate in the circumstances. I agree and costs are awarded accordingly.
MORAWETZ J.
Date: April 27, 2012