“Risk Management Strategies for Lessors” Article

Risk Management Strategies for Lessors

Any business venture comes with an element of risk. The best that people can do is to try to minimize that risk as much as possible. A landlord takes on a new risk with each lease signed. Perhaps the most obvious threat is the failure of the tenant’s business and the corresponding lost rental income and costs to replace the tenant.

There are a number of strategies that landlords can employ to minimize the uncertainty – and most can be employed before the lease is ever signed.

Choosing the right tenant

Thorough investigation into the quality and financial ability of a prospective tenant can help to avoid a problem before one ever exists. Such due diligence should include verification of the business, its principles (especially if the business is not incorporated) and guarantors. Some options:

If the tenant is a publicly traded company, a free search of the company on SEDAR will show myriad information including financial records and press releases. SEDAR is the System for Electronic Document Analysis and Retrievals, a mandatory document filing system for Canadian public companies. These documents can be very informative with respect to the tenant’s current and prospective financial situation.

A search of the personal property security registry may show some assets of the tenant and claims to those assets by other creditors.

A land title search will show if any real property is owned by the tenant. This can be particularly useful for unincorporated businesses (in which case the landlord would be interested in the holdings of the proprietors) and for searching the assets of guarantors, as a landlord may be in the position of claiming against a guarantor. Many businesspeople put property in the name of their spouses. If a prospective tenant has protected himself or herself this way, the landlord may demand that the spouse execute a guarantee.

A credit search can also be useful. A sole proprietor with a poor credit rating may be seen as an undesirable tenant. If the proposed guarantor has poor credit, the landlord may insist on another individual executing a guarantee.

Searching the court registry can prove to be very useful. Most court files are matters of public record. This is particularly so of commercial disputes. A quick and inexpensive search of the court registry can reveal whether the tenant or its principals are involved in any lawsuits. If so, documents filed with the court – including the claim, defence, affidavits and court orders – can be viewed and copied. A prospective tenant involved in a number of lawsuits may be seen to be too great a risk.

Drafting the lease

Once the due diligence is completed, the best way for a landlord to minimize risk is through a carefully drafted lease. Some issues that should be considered:

The first rule in drafting a lease is not to follow precedents slavishly. While precedents serve a very useful function and are a good place to start, landlords need to ensure that contracts are up-to-date with the law. They also need to ensure that their business plans will be protected and/or advanced by the lease.

One must be sure to avoid what I call “Mr. Potato Head leases”. These are leases that start with a precedent and add clauses from another, and another clause from yet another lease, and so on. While individually the clauses make sense, they may not work well together. Just like a Mr. Potato Head toy with various unrelated pieces stuck into it.

An example from the construction world illustrates what can go wrong when leases are not worded carefully. In Grace Residences Ltd. v. Whitewater Concrete Ltd. the developer “Grace” and the concrete formwork contractor “Whitewater” signed a standard form contract. They added a term to that contract dealing with use of the tower crane by Grace when Whitewater was done with it. The added clause stated that Grace would pay for the tower crane rental upon Whitewater achieving “substantial performance of the work”. The phrase “substantial performance” was defined in the standard contract, but “substantial performance of the work” was not defined in the additional clause. An arbitrator determined that “substantial performance” meant something other than “substantial performance of the work”. As a result, Grace paid for about $80,000 of crane rental charges that it thought were the responsibility of Whitewater. Had the parties taken the time to review the added clause in the context of the large contract the confusion of language would have been spotted and corrected, and Grace would have saved a lot of money.

Similarly, landlords must be sure that important words and phrases are defined in the lease. Many phrases that may seem to have an obvious meaning do not. The case Rumrunner Pub Ltd v. Seaport Place Holdings ULC provides a good example of this: the lease provided that the landlord could insist that the tenant undertake “major improvements” as a condition to the tenant exercising its option to renew. The court found that “major improvements” was a vague term and therefore unenforceable during a subsequent dispute.

During the lease

“An ounce of prevention is worth a pound of cure” not only applies to our health but also how we administer our contracts.

Litigation is expensive, time consuming and risky. Obtaining relatively inexpensive advice as to your rights and obligations as issues arise during the lease can help prevent a very expensive dispute or mistake.

Often, the only people who read lengthy contracts and leases are the lawyers that negotiate them. Clients are then sent on their way and expected to manage their relationship, the terms and conditions that govern (which are in a document read by neither party). The parties then make decisions that affect their rights and obligations without a full understanding of the consequences of those decisions.

Lawyers are frequently presented with problems that have been ongoing for months. Most often, these problems could have been avoided or the impact could have been minimized if the landlord had done a thorough background check on the tenant and reviewed the lease in detail both before and during tenancy.

*** Disclaimer ***

These materials are produced for information purposes only and do not amount to legal advice. Provision of these materials is not intended to, and does not, create a solicitor and client relationship between the author and the reader. The reader should always seek the advice of a qualified professional in respect of his or her specific situation.