Ontario Court of Appeal illustrates the power of indemnification agreements

A decision by the Ontario Court of Appeal has clearly and unambiguously clarified the far-reaching nature of indemnity agreements for commercial leases. The Court held that an indemnifier to a commercial lease is inextricably bound to the terms of the indemnity, despite the language of the lease and the underlying context of the agreement.

In Parc Downsview Park Inc. v. Penguin Properties Inc., a tenant defaulted on its obligations under its lease. The landlord was unable to collect rent and other losses from the tenant and consequently turned to the indemnifier. The indemnifier refused to pay the amounts owing to the landlord and the landlord brought an application to enforce the indemnity agreement.

The application judge allowed the application and ordered the indemnifier to pay all amounts owing up to the day the application was heard, citing the landlord’s duty to mitigate its loss as set out in the lease. The indemnifier appealed the decision and the landlord cross-appealed, arguing that the indemnifier was liable for rent owing until the end of the term, not just rent owed up until the date the application was heard.

The Ontario Court of Appeal held that the application judge made an error by drawing a connection between the landlord’s responsibilities to the tenant under the lease and the landlord’s responsibilities to the indemnifier under the indemnity agreement. It found that there was no language in the indemnity agreement to support that connection and furthermore, that making such a connection ran contrary to the plain language of the indemnity agreement.

 THE FACTS

In 2010, Parc Downsview Park Inc. (the “Landlord”) and the National Squash Academy Inc. (the “Tenant”) entered into a lease of premises in Toronto. The Tenant defaulted on its obligations under the lease and negotiations began between the parties to enter into a new lease. The Landlord made it clear that if there was to be a further lease, it would require a guarantor to indemnify the rental obligations of the Tenant.

The principal of Penguin Properties Inc. (the “Indemnifier”) played squash at the Tenant’s facility and agreed to enter into an indemnity agreement with the Landlord. Under the agreement, the Indemnifier agreed to “indemnify and protect the Landlord from any losses or costs incurred by the Landlord (including legal fees) if the Tenant fails to pay the rent in respect of the 12,721 square feet” and that “[t]he Indemnifier is not a mere guarantor, the Indemnifier is primarily responsible for the Tenant’s obligations for the payment of rent in respect of the portion of the premises comprising 12,721 square feet”. The indemnity agreement was executed together with a new lease in July 2012.

In September, 2013, the Tenant defaulted on its obligation to pay rent under the new lease. After two years of unsuccessful negotiations, the Landlord delivered a termination notice to the Tenant and shortly thereafter, the Tenant made a voluntary assignment into bankruptcy.

In November, 2016, the Landlord gave further notice of default to the Indemnifier under the indemnity agreement. The Indemnifier refused to pay the amount owing and the Landlord commenced an application under the indemnity agreement for unpaid rent, future rent and other costs and losses.

The Indemnifier argued that it was not responsible for the losses because the Landlord induced the Indemnifier into entering the indemnity agreement by misrepresenting that the Landlord intended to make certain improvements to the location. The Landlord denied this.

The application judge allowed the Landlord’s application. The judge concluded that the Indemnifier was not merely a guarantor, but a primary debtor. The judge held that the indemnity agreement was an acceptance of an obligation to pay not only the rent but all losses and costs suffered by the Landlord as a result of a failure of the Tenant to pay the rent. The Indemnifier was ordered to pay all amounts owing up to June 12, 2017, the day the application was heard.

The Indemnifier appealed this decision, asking the Court to set aside the judgment and convert the application into an action. The Landlord cross-appealed, seeking to vary the judgment to include an order that the Indemnifier pay the remaining rent due up until the end of the lease term, less any rent received from new tenants during that period.

The Court of Appeal dismissed the Indemnifier’s appeal and allowed the Landlord’s cross-appeal. The Court held that the application judge erred in failing to give effect to the plain language of the indemnity agreement and instead examined the Landlord’s entitlement to future rent from the perspective of its obligations under the lease as a landlord to its tenant, rather than its rights under the indemnity agreement as against its Indemnifier. The Court of Appeal further held that, although the Landlord owed the Tenant a duty to mitigate its losses for rent due after June 12, 2017, the Landlord owed no such duty to the Indemnifier. In other words, the Indemnifier owed a greater obligation to the Landlord than did the Tenant. The Court concluded that the language of the indemnity agreement clearly stated that the Indemnifier was to “indemnify and protect the Landlord from any losses or costs incurred by the Landlord if the Tenant fails to pay the rent” [emphasis added]. The Court of Appeal held that as a sophisticated, commercial party, the Indemnifier should have understood the onerous nature of the indemnity agreement.

THE TAKEAWAY

This case serves as a warning to any party entering into an indemnity agreement. If the agreement is drafted broadly enough, an indemnifier may be on the hook for all past and future losses incurred by the Landlord.

Interestingly enough, Justice van Rensburg, in dissent, disagreed with the Court and stated that the application judge made no error in considering the terms of the lease relative to his interpretation of the indemnity agreement. Justice van Rensburg stated that the application judge’s analysis considered the entire factual matrix of the indemnity and that his interpretation was not contrary to the plain language of the indemnity agreement.

Nevertheless, the Court of Appeal has made it clear that indemnity agreements will continue to be a powerful tool in commercial leasing. It is important that parties who wish to limit their liability clearly include those limitations in their indemnity agreements.

 

Daoust Vukovich LLP offers guidance and practical assistance on every aspect of commercial real estate law in Ontario and across Canada. Visit www.dv-law.com for more information.

This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice.

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