"Capital Repairs" - An Update

Many of you will recall an earlier Legal Corner article (June 2012) where I wrote about the Ontario decision in RioCan Holdings Inc. vs. Metro Ontario Real Estate Limited.

That decision held that the landlord was not able to recover parking lot re-surfacing costs from its tenants as part of CAM based on the lease wording, as the Court found that the resurfacing work was a capital expenditure, expressly excluded from CAM in the lease and so not chargeable under the lease (notwithstanding the cost was amortized over the useful life of the parking lot).

In the 2012 decision of the Ontario Superior Court of Justice in Parsons Precast Inc. v. Sbrissa, (released after the Riocan decision), a similar situation arose where a landlord was trying to charge-back and recover the cost of repaving from its tenants.

In Parsons, the tenant leased commercial space in a multi-tenanted project for an initial three-year term, which was renewed twice with expiry ultimately occurring on Oct. 31, 2011.

The lease was a “completely care-free net lease” with the tenant paying its “proportionate share of all expenses…., including…., all expenses arising from… common area maintenance expenses…”.

In addition, the Tenant was required to pay monthly its proportionate share of “all costs and expenses incurred by the landlord in maintaining, operating, cleaning, insuring, and repairing the property…”

With just over one year left in the Term, the Landlord notified its tenants of a re-paving expense of over $76,000 that had been incurred for the parking lot. The Landlord’s notice to Parsons advised that its proportionate share of the repaving cost was about $14,500 and payment was required on a lump sum basis (the landlord did not amortize the costs).

Parsons refused to pay and vacated the premises on Oct. 31, 2011 being the lease expiry date.

Parsons applied for an interpretation of the lease and relied on the RioCan case to support its argument that it was not responsible for the repaving cost.

However, the Court held that the RioCan case was different than the facts in Parsons since in the RioCan case, “expenditures which by accepted accounting practice are of a capital nature” lease were expressly excluded from additional rent.

So, once the repaving was found to be capital in nature, the tenant was not responsible for its cost. However, in Parsons, no such similar capital cost exclusion was in the lease.

Next, the Court focused on whether the repaving was “maintenance” or a “repair (but subject to the “reasonable wear and tear” exception) which were the responsibility of the Tenant in the Parsons lease.

The Court learned that the parking lot was approximately 19 or 20 years old when the repaving was carried out; and determined that its deterioration was due to “wear and tear”. As a result, the repaving of the parking lot fell under the “wear and tear” exception and was not recoverable from Parsons as a “repair.”

In addition, the Court considered the meaning of “maintenance”. The Court found that it meant the concept of “keeping the property up” and that a complete repaving was not in the nature of merely “keeping up” the parking lot but was rather a replacement of it which was beyond the scope of “maintenance”.

So the Tenant was not liable for it as “maintenance” either.

Although that was determinative of the matter, the Court also mentioned that the Landlord billed the Tenant for its entire share as a lump sum and not an amortized amount over the useful life of the parking lot indicated that the cost was not in the nature of “maintenance” or “repair” as this was not the common approach for charging common area costs; as such costs were normally estimated for the year and billed on a monthly basis.

Finally, the Court found that even if Parsons was liable to pay its proportionate share of the repaving cost, it would be “unfair and unjust” for the landlord to charge it on an unamortized basis since that work increased the life expectancy of the parking lot by up to 20 years while Parsons had just over one one year left on its lease.

The Lesson:

1.  As always, accurate drafting must be an objective – especially where there can be significant monetary ramifications to the parties, so consider defining a “capital repair” (with examples) and how it will be charged back – lump sum v. amortized. This will cause the parties to assess the building in terms of age and condition so their expectations can be met with less surprise.
2. As a landlord, consider having your lease provide for a “capital reserve fund’ as part of your CAM so there are monies available to fund – in whole or in part – capital repairs as they arise.
3. As a tenant, make sure all capital repairs are amortized and not charged back on a lump-sum basis.
4. A tenant should try to carve-out liability for major CAM expenditures during its last 1-2 years unless they are amortized over their useful life given the tenant will not benefit from them afterwards.
5. In cases where the tenant is a single-tenant user and is responsible for capital repairs, there should be a formula for recovery from the landlord of capital costs incurred by the tenant where the useful life of the repair exceeds the remaining lease term.

Disclaimer: This article is for general information purposes only and not intended as or to be relied upon for legal advice. Consult with a lawyer for your unique situation.

[*If there is a general real estate or leasing-related question you would like to see addressed in a future article in “The Legal Corner”, please contact me directly by e-mail at dgold@robapp.com with your suggestion. Not all requests can be accommodated.]

As published in Property Biz Canada on June 19, 2013