Piercing the tenant’s corporate veil
With the word “recession” now being bandied about as a virtual fait accompli, it won’t be long until landlords will again have to deal with the spectre of massive tenant defaults throughout their portfolios. While establishing tenant defaults will, generally speaking, not be so difficult to do, the transition from proving tenant default to practical full monetary recovery is much more complicated. Tenants have learned to structure their affairs so as to essentially credit-proof the assets of the entity that ultimately stands behind the lease. That is, through the use of shell corporations, subsidiaries, subleases, assignments and other methods or arrangements, tenants, especially corporate tenants, are finding ways to shield themselves from ultimate liability for unpaid rent and other damages proven to be owing to their landlords. While a court may find that a corporate tenant is liable for a breach of contract, the victory is often a pyrrhic one unless the landlord can get at the real source of the tenant’s assets. What’s worse, in the case of non-rent defaults, the landlord is often left in a hopeless position of being unable to compel specific performance against related companies that continue to defy the terms of the lease.
One solution for landlords is to sue not only the corporate tenant for breach of lease, but also the shareholders, directors, officers and others standing behind the corporate tenant, a legal manoeuvre often referred to, appropriately enough, as “piercing the corporate veil.” Two very recent cases highlight the extent to which landlords have developed the art of piercing their tenant’s corporate veils. Although most Building readers are familiar with famous torts like negligence and slander, there are a host of other lesser-known torts (being the “legalese” term for lawsuits that do not require some form of contract directly linking the litigants) that are commonly invoked to try and pierce a corporate veil.
In J. S. M. Corp. (Ontario) Ltd. v. Brick FurnitureWarehouse Ltd. (the Brick Warehouse case), a 2006 Ontario decision, The Brick, as tenant, initially subleased its premises to a subsidiary that, in turn, assigned its interest under that sublease to another related company. The ultimate assignee company then purported to terminate the lease, and ceased paying rent altogether. The landlord brought a lawsuit against the original corporate tenant, the corporate subtenant and the subtenant’s assignee for damages arising from the breach of the lease. For good measure, the landlord also raised a claim against the individual directors and officers of these corporations for the tort of inducing the breach of contract and intentional interference with economic relations.
The court found all of the corporate entities jointly and severally liable for the breach of lease, but the landlord really needed to get at the assets of the directors for any prospect of a full recovery. As to the tort of inducing breach of contract, the court found all of the directors guilty of inducing the breach, but not liable for the landlord’s damages resulting from that breach because of the general rule protecting corporate officers and directors who cause their companies to break contracts, but do so in a bona fide manner and in the best interests of those corporations. This rule, first established in England in 1920, left the directors not liable for the landlord’s loss, even though they directly caused their companies to default under their leases.
The court in the Brick Warehouse case went on to consider another tort, the tort of intentional interference with economic relations. While this tort is similar to the tort of inducing breach of contract, the required elements are not quite identical. In order for the landlord to succeed in the tort of intentional interference with economic relations, the landlord had to show that the tenant’s directors interfered with the landlord’s business by unlawful means. Here, the court found that while the directors had caused their corporations to breach the lease, the directors “did not themselves employ unlawful means in order to do so.” They simply acted as directors or officers. In these capacities, they had lawful justification to act in the interests of their corporations and, in fact, it was their obligation to do so.
In 1175777 Ontario Ltd. v. Magna International Inc. “the Magna case”, another recent Ontario case, a lawsuit was initiated against the tenant corporation for breach of contract, and similar to the Brick case, a claim was also brought against the individual directors of the corporation, including the tenant’s well-known director, Mr. Frank Stronach. The landlord asserted that it had entered into an agreement with a Magna subsidiary for the lease of a new building that the landlord was constructing. Magna disputed the existence of a binding lease agreement, which forced the landlord to cease construction partway through the process. Subsequently, the landlord sued Magna for breach of contract, and Mr. Stronach personally for the tort of intentional interference with economic relations and for the tort of conspiracy to injure.
Ultimately, the court found that any discussions regarding a lease agreement between the landlord and the tenant had never been finalized. Since there was no valid contract between the parties, there could be no damages against Magna for breach of contract. However, the case remains significant for its discussion of the individual tort claims against Mr. Stronach. In this case, the Ontario Court of Appeal considered whether the claim for intentional interference with economic relations against Mr. Stronach personally should be allowed to proceed. The court found that this tort could not proceed. Just as in the Brick Warehouse case, the court noted that the lawsuit never actually alleged conduct which was, in and of itself, unlawful. The court did, however, allow the lawsuit for the tort of conspiracy to injure to proceed. The essence of the conspiracy claim was that Mr. Stronach’s predominant purpose in not proceeding with the lease was expressly to harm the landlord’s principals, mainly as revenge for past disputes between the two in previous lease arrangements. The court ultimately disagreed as a matter of fact with this conspiracy theory, noting that Magna’s decision not to go through with the lease of the new building was at least ostensibly for valid business reasons. Therefore, as in Brick Warehouse, the person behind the corporate tenant was able to avoid any personal liability because he had been acting consistent with the best interests of his corporation. That said, the Magna case introduced the tort of conspiracy to injure to the arsenal of tort claims that an aggressive landlord can use to try to pierce the tenant’s corporate veil.
Although the Magna and Brick Warehouse cases paint a relatively dim picture of the odds of success in using various torts to pierce the tenant’s corporate veil, such litigation is not always so futile. In Torgan Enterprises Ltd. v. Contact Arts Management Inc., a well known case from the late 1990s, professional offices were leased to a corporation, the principal officer of which was one Mr. Jimmy K. Sun. Mr. Sun operated his law practice out of those leased offices, supposedly as a subtenant of the corporate tenant. Prior to the expiration of the lease, Mr. Sun moved his law practice to better offices nearby and then, in his capacity as officer of the corporate tenant, caused the corporate tenant to stop paying rent. While the landlord’s lawsuit against the corporate tenant for breach of lease was a veritable “slam dunk,” the landlord was also successful in a lawsuit against Mr. Sun personally for the tort of inducing the breach of contract. The court found that Mr. Sun was the “alter ego” of the corporation and did not keep the distinction between the two entities — the corporate tenant and himself — sufficiently clear, even to himself. The court noted, for instance, that Mr. Sun would frequently wr
ite letters personally to the landlord identifying himself as the “tenant,” even though he actually only ever intended to be the subtenant of the corporate tenant. The court held that, in abandoning the leased premises and moving his law practice to better premises elsewhere, Mr. Sun was not really acting as an officer in the best interest of the corporate tenant, but rather in his own best personal interest. As such, Mr. Sun was found personally liable for inducing the breach of the lease and for having caused all of the landlord’s losses.
These three cases demonstrate the use of various torts to pierce the tenant’s corporate veil. Although, as the Brick Warehouse and Magna cases (and many others) show, the general rule protecting officers and directors from personal liability is very effective indeed, the Jimmy K. Sun case demonstrates that, given the right circumstances, landlords can indeed use tort to pierce the corporate veils of some tenants seeking to avoid liability for their breaches.
Jeffrey W. Lem, B. Comm. (U of T), LL. B. (Osgoode), LL. M. (Osgoode), practises in the areas of commercial real estate and finance with the law firm of Davies Ward Phillips & Vineberg LLP, and has been called to the bar in Ontario, England and Wales. He is an executive member of the Real Property Section of the Ontario Bar Association and is editor-in-chief of the Real Property Reports, published by Carswell Thomson Professional Publishing. Daniel S. Remick is a student-at-law articling with Davies Ward Phillips & Vineberg LLP. This article provides general information only and is not intended to provide specific legal advice. Readers should not act or rely on information in this article without seeking specific legal advice on their particular fact situations.