[vc_row][vc_column][vc_column_text]June 2, 2008

By Brian Babcock

Developers and landlords must bear their own losses if they fail to secure a binding contract with a proposed tenant before commencing construction or renovations. Because prospective tenants often place a premium on early availability, and because rent usually does not start until the premises are usable, landlords often forge ahead with substantial work without a contract, or with only an offer to lease or letter of intent.

Ontario’s Court of Appeal, in a case called 1175777 Ontario Limited v. Magna International Inc., upheld a trial judgment which reviewed the principles that apply to such a situation. The trial judge relied heavily upon evidence of the surrounding circumstances of the lease negotiations, and closely considered the significance of a letter in which the developer set out an offer to lease. One Magna executive had signed, apparently accepting the offer, but the offer itself reflected an understanding that a second executive would also have to sign.

In spite of only having one signature, though he knew both were required, the developer had started construction on a new factory for the auto parts maker, knowing that Magna needed a facility urgently to fulfill a specific parts order. Unfortunately for him, Magna decided to acquire other space, and he was left with a building and no tenant. He sued.

Perhaps most importantly, all of the evidence about the negotiations, as interpreted by the judge, showed that the parties all understood that the letter was not a binding agreement. The letter referred to a formal lease to be prepared by the parties’ lawyers. There was no reference to any particular form, and although Magna had other leases with the developer, they were not all the same. Because further negotiations were necessary, no binding agreement existed.

In addition, the judge reminds us that in order for a lease (or agreement to lease) to be binding there must be certainty as to:

1. the parties,
2. a description of the premises to be leased,
3. the commencement and
4. duration of the term,
5. the rent, if any, and
6. all the material terms of the contract not being matters incident to the relation of landlord and tenant, including any covenants or conditions, exceptions or reservations.

In the particular case, the letter was found to not satisfy requirements 2, 3 and 6.

Although courts do not expect agreements to be perfect, they must set out the parties’ intentions or agreement clearly enough that a judge knows what the terms are. The fact that one party may have acted as if there was an agreement is not enough.

In this case, the building was constructed on a large parcel of land. Reference was made to parking and storage, and a possible expansion (an option). Nothing in the letter specified where the parking, storage, or expansion would be located, or how much of the parcel was included. The developer did not help his case when he himself gave different versions of his understanding at different points in his evidence.

Perhaps more surprising was the judge’s conclusion that the commencement date was uncertain. As the judge says, “The parties must specify a date or a formula for determining the commencement date. By linking the commencement date to a stated event, the uncertainty is removed”.

The letter stated that the building was to be completed in March 1997. The developer argued that this was the commencement date. Since Magna was in a hurry, the inference could be made that they would take possession and the lease would begin then. The judge instead decided that the would ‘completion’ is unclear. She suggested at least three different tests to determine completion:

1. a state of completion sufficient for Magna to commence installing its heavy equipment in the bay area of the building
2. that the offices would also have to be ready to be occupied, the parking lot paved or the landscaping done ( this alone could create three or more dates).
3. ‘substantial completion’ as this term is used in a construction lien context.

These could all be different dates. The letter was uncertain.

The judge then found that the terms of the option to expand the building were uncertain, that these were ‘material terms’ and that the letter therefore did not satisfy the 6th test either.

Sometimes, where the law will not allow recovery because there is no binding agreement, a developer might be compensated for losses under the equitable remedies which prevent “unjust enrichment”. That was not considered in this case, probably for good reasons. These principles apply only where there is an incomplete or ineffective contract, and BOTH parties act as if they believed that they had an agreement. Although Magna had prepared some preliminary estimates and drawings about plant setup, the judge found that Magna never considered itself to have made a commitment, and, neither did the developer. He gambled that Magna would need his building, and that everything would work out. He lost. Magna was not enriched, and losing at gambling is not unjust.

The lessons to be learned from this decision include:

1. be sure that both parties have the same understanding of the agreement
2. If you want a binding agreement to lease, satisfy the six certainties
3. prepare any written evidence of the agreement carefully, avoiding vague terms
4. do not refer to a ‘lease to be negotiated’ or similar language – refer only to an existing lease, or a standard form
5. if you can not satisfy these requirements, you start construction or renovations at your own risk.

Where significant investments are being made before a formal lease is signed, a lawyer can assist the developer by drafting clear unambiguous documents, whether the intention is to have a binding agreement, or something less formal.[/vc_column_text][/vc_column][/vc_row]