During the closing of a real estate transaction, purchasers are often pre-occupied with securing financing for the property, obtaining insurance, and other matters that are commonly recognized as being the crux of completing a deal. One issue that is not considered as frequently is whether an open building permit exists on the property. As open building permits are not registered on title, they can be an overlooked issue that may lead to upsetting consequences for the parties involved.
What is an Open Building Permit?
A building permit is an authorization from a municipality for specific works to be completed on a property. Such works can include: demolitions, additions, material renovations, and other types of construction on property. The construction of a patio, the installation of a HVAC system, and even altering a new plumbing or mechanical system, are all examples of works that often require building permits.
A building permit is issued so as to ensure that the project complies with building, zoning, land-use, and safety standards relevant to the jurisdiction in which the property is located. Each jurisdiction will have its own process for applying for a building permit, but the process often involves an application consisting of submitting draft plans for approval from a local municipality, obtaining permission for the construction, and eventually receiving a final inspection in order to confirm that the proposed work is complete and in accordance with the permit issued, leading to the open building permit being closed.
How Does an Open Building Permit Affect the Sale of Real Property?
If an open building permit exists on the property, it can have potentially damaging consequences depending on the type of building permit that was opened and the remaining incomplete work on the property. An open building permit means that the municipality has granted approval for a project on the property, but the extent to which work has been completed and whether it is in accordance with the approved permit, remains unknown. If work was completed but is not in accordance with the permit, municipal inspectors can issue work orders for deficiencies, as well as for violations of codes governing the property. Such orders may involve only minor work to be performed in order to bring the construction into compliance, but others can involve the need for substantial work, leading to unforeseen costs and time required in order to close the permit. For example, in the 2013 decision of the Ontario Superior Court in 1854822 Ontario Ltd. v The Estate of Manuel Martins (Martins), the solicitor for the purchaser discovered an open building permit for work on a dilapidated garage on the property. The subject garage had to be demolished and rebuilt at a cost of $110,000.00. This case provides a clear example of how open building permits can pose a serious financial risk and lead to litigation.
The Law Related to Open Building Permits in Ontario
During a real estate transaction, the purchase agreement often provides the potential purchaser the ability to make title requisitions which will identify problems or deficiencies or matters that could defeat "good and marketable title" with respect to the subject property. Typically, the vendor will then work to rectify the problem or deficiency. All of this occurs within a prescribed time period set out in the purchase agreement.
Often requisition clauses in purchase agreements do not explicitly reference open building permits. Therefore, the question that begs to be asked is whether an open building permit is a cloud on title, affecting whether the purchaser can receive "good" title.
Interpreting Issues of Good Title and Open Building Permits in the Courts
While there is no streamlined definition of what is considered "good" title, a commonly accepted definition comes from a 1978 Ontario Court of Appeal case in which the presiding justice confirmed that good title means a marketable title. Writing for the Court, Justice Lacourciere confirmed that a marketable title is:
one which at all times and under all circumstances can be forced upon an unwilling purchaser who is not compelled to take a title which would expose him to litigation or hazard: one which is free from litigation, palpable defects and grave doubts and couples a certainty of peaceful possession with a certainty that no flaw will appear to disturb its market value.
Historically, issues relating to zoning and building infractions have not been accepted as a vendor not being able to provide good title. However, a turning point in the case law occurred in three recent Ontario cases. In Thomas v Carreno, prior to closing, the purchaser discovered that there was an open building permit for construction on the property and requisitioned it to be closed. The vendors were unable to close the permit before closing but arranged for a title insurance policy and a holdback of funds so that the deal could close. The purchaser then sued for the return of their deposit. Unfortunately, in this case the court skirted around the issue of declaring whether an open building permit is a valid objection to title. Instead, Justice Lederman commented that due to the potential for substantial work that would need to be performed, this would likely amount to work orders being issued (something that is often explicitly included in purchase agreements as creating a cloud to title). According to Justice Lederman:
From the evidence it would appear that the building permit related to a fairly substantial renovation and, thus, the potential risk and exposure to the Applicant was significant. The City could have imposed extremely onerous work orders which certainly would affect the Applicant's use and enjoyment of the property. The Applicant would be subject to the possibility of facing significant remedial construction and possible litigation. In the face of an open permit, the property remains subject to the possibility of a work order.
While Justice Lederman never explicitly concludes whether an open building permit is a defect on title, he held in this case that the purchaser "was not entitled to terminate the Agreement once the vendors obtained a commitment for title insurance and offered to provide it in accordance with paragraph 10 of the Agreement." On appeal, the Ontario Court of Appeal found that the lower court correctly concluded that "the requisition in relation to the open building permit could be 'satisfactorily answered by a commitment to provide title insurance as contemplated by the Agreement of Purchase and Sale.'" Although this case does not explicitly answer our question of whether an open building permit is technically a cloud on title, we do see the courts connecting the high potential for a work order to be issued as a consequence of the open building permit. It is worth keeping in mind, however, that the court's decision in this case turned on the availability of title insurance to remedy the issue of the permit.
In the 2013 Ontario Superior Court decision in Martins, mentioned above, the court held that an open building permit went to the root of title. In this case, a dilapidated garage was present on the property and although the purchaser was aware of the condition of the garage prior to executing the agreement of purchase and sale, he was not aware of the existing open building permit relating to the garage. Justice Wilson ultimately recognized the significant amount of work and costs associated with eventually closing the permit (i.e. demolishing the garage). As such, Justice Wilson held that:
What is clear to me is that the existence of the open building permit does make a difference to the Applicant's position. On the facts of this case, there is a risk of litigation down the road and the purchaser's right to enjoyment of the property is by no means certain. In my opinion, the open building permit is not a minor defect; rather, it goes to the root of title and constitutes a valid objection to title.
As such, the court found that the seller of the property had not shown good title to the property pursuant to the agreement of purchase and sale. In this case, Justice Wilson made a leap in holding that an open building permit would go to the root of title due to its potential to have a substantial impact on the purchaser. In fact, the court took notice of evidence that such work in response to an inspection could come at a cost of $110,000. In this case, although there was no evidence of a work order being issued by the city with respect to the building permit, the mere existence of the open permit would allow the city to inspect, which could have a significant impact on the purchaser.
In the 2015 case of MacDonald v Chicago Title Insurance Company of Canada, the Ontario Court of Appeal was tasked with interpreting a title insurance policy, and specifically whether the issue at hand was insurable under the policy. In this case, the purchaser bought the subject property in 2006 and as part of the purchase, acquired a title insurance policy which provided that one of the covered title risks included a situation where:
Your Title is unmarketable, which allows another person to refuse to perform a contract to purchase, to lease, or to make a mortgage loan.
The policy continued by providing coverage related to work orders, defects, liens, and so on. Years after closing, the purchaser received a notice of a work order for the property relating to work that had been completed on the property without a valid building permit. The purchaser brought a claim against the insurance company to recover under the policy. On appeal, the court held that what must be determined is whether the defect in issue had rendered the property unmarketable in accordance with the title insurance policy coverage (i.e. whether a potential purchaser could refuse to close an agreement of purchase and sale upon learning of the defect), and from there, whether coverage was excluded under the exclusions or limitations of liability provisions of the policy.
Justice Hourigan, writing for the court, held that the failure of the previous owners of the property to obtain the necessary municipal approval did make the purchaser's title unmarketable within the meaning of the title insurance policy. Justice Hourigan further commented that had the previous owner sought permit approval, it likely would not have been granted as the work included dangerous construction. In this case, the court took a liberal approach to interpreting the insurance policy, ultimately querying whether the defect made the property unmarketable, as opposed to the "title" being unmarketable.
While historically speaking the courts have taken a stricter approach to determining how building permit issues would be treated during the sale of a property, recent iterations have strayed from this strict approach. As noted, the courts have been inclined to find that building permit issues can affect title (in the case of Martins), or in the case of MacDonald, that they can affect the marketability of the property, which the court saw as affecting title.
Lessons to be Learned
Although in some cases the courts have allowed building permits to be addressed in similar manners to title issues, it is important to note that an open building permit may not necessarily go to the root of title. To date, judicial decisions have been results-based in the specific circumstances of the case, often attempting to fit building permit issues somehow within the ambit of the contract. The extent to which the courts will offer protection in this regard appears to come down to how substantial the "defect" caused by the open permit could be. Could the inspection of the permit-related alterations significantly vary what the purchaser had bargained for in the agreement of purchase and sale? In this respect, courts can examine the marketability of the property generally, and are not limited to an examination of the marketability of title on its own.
As a vendor, it is important to take precautions with respect to building permits that have yet to be inspected and closed. The case law referenced in this article provides examples of where courts have been willing to extend protection to purchasers with respect to open building permits. As a vendor, it will not only be important to require purchasers to acquire title insurance to remedy deficiencies, but also to ensure that it includes a clause with respect to open permits, and that it covers the purchaser. Vendors should be cautious about purchasers being unwilling to close and the parties should consider obtaining title insurance that covers outstanding building permits on the subject property.
Purchasers should ensure that permits are closed before the closing of the sale, potentially extending the closing if necessary. If a purchaser obtains an owner's title insurance policy, a caution should be provided, however, that title insurance will likely become unavailable upon an insurer being made aware of an open permit or the open permit will be a specific carve-out not covered by the insurance policy. This is something to consider prior to informing a client about the possibility of searching for open building permits on a property.
A preferred solution is to include a reference to closing any open building permits in agreements of purchase and sale, particularly in the residential context. In a commercial context, such permits will likely be included within off-title due diligence searches that are typically conducted, but it is important to be aware that a vendor may refuse to take steps to close the permit. As such, even commercial agreements of purchase and sale should take into account the risks of finding open building permits.
The takeaway, in particular from the case law in the area, is that courts will analyze the materiality of the defect caused by the open building permit to determine whether the purchaser received what it had ultimately bargained for, as a matter of the law of contract. Open building permits, when their status is unknown, can lead to significant risk, including undesired litigation.