The Ontario Court of Appeal’s recent decision in Hudson’s Bay Company v OMERS Realty Corporation1addresses a novel lease transfer issue that goes to the heart of the difference between “control” and “interest”. Justices Gillese, MacFarland and van Rensberg, confirming the decision of Justice Conway in the original application (the “Application”),2 determined that it was not necessary to look beyond the proposed lease assignments to make a determination regarding ultimate property interests.
The dispute arose as a result of the joint venture formed between Hudson’s Bay Company (“HBC”) and RioCan Real Estate Investment Trust (“RioCan”) in 2015. HBC intended to assign three of its shopping centre leases (the “Leases”)3 to the joint venture, giving RioCan a beneficial ownership interest in the Leases. The landlords for all three locations were represented by Oxford Properties Group (“Oxford”), the real estate arm of OMERS. Oxford refused to consent to the assignments (effectively because RioCan and Oxford are competitors),4 and the parties agreed to bring the Application to the court under section 23(2) of the Commercial Tenancies Act.5 On the Application, HBC sought a declaration that consent was not required for the assignments or, alternatively, that the landlords had unreasonably withheld consent.
The HBC-RioCan Joint Venture
The HBC-RioCan joint venture involves two limited partnerships – RioCan-HBC LP (the “First LP”) and HBC YSS LP (the “Second LP”). In the First LP, HBC holds approximately 90% of the partnership units and RioCan holds the remaining 10%. The sole general partner is jointly controlled by HBC and RioCan (each of which have a 50% interest), and this general partner holds all of the assets of the joint venture except for the Leases. The Leases are held in the Second LP. In the Second LP, HBC is the general partner, and the First LP is the limited partner holding a 99.9999% interest.
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The Leases, while providing a general restriction on assignments without landlord consent, each allow for transfers to an affiliate of the existing tenant (the “Affiliate Exception”). “Affiliate” is defined in each lease as follows:
- In the Yorkdale lease, “Affiliated Corporation” is defined as a “holding corporation, subsidiary corporation or affiliate of Tenant, as each of those terms is defined in the Canada Business Corporations Act.” Pursuant to the Act, two corporations are “affiliated bodies corporate” if each of them is controlled by the same person.6
- In the Square One lease, “Affiliate” is not specifically defined but the comparable section provides that “HBC LP Inc. may, without consent…assign this Bay Lease or sublease the whole or any part of the Leased Premises to any company which is related to the Tenant (being any company which is a parent, subsidiary or controlled in common with the Tenant)”.
- In the Scarborough Town Centre lease, “Affiliate” is defined as “…any corporation, any person, firm, association or corporation which controls, is controlled by, or is under common control with, such corporation.”
Given these definitions, the question of whether the Leases could be assigned turned on whether there had been a change in the control of the tenant entity. If the Leases were assigned to an entity that was jointly controlled by HBC and RioCan, it was Oxford’s position that consent was required.
To address this issue, HBC intended to use the limited partnership structure to assign the leases from itself as commercial tenant to itself in its capacity as the general partner of the Second LP. The Second LP would then sublease the premises back to HBC as commercial tenant on a full pass through basis. InHBC’s view, it would continue to have control over the Leases as the general partner of the Second LP, to whom the Leases were being assigned.
Nature of a Limited Partnership
The parties agreed that pursuant to this structure, HBC as general partner would hold legal title to the Leases. Limited partnerships (and partnerships generally) are not permitted to be registered owners of real property in Ontario.7 As a result, the general partner of a limited partnership typically holds title. This prohibition stems from the inherent passivity of limited partners. The prohibition was discussed at length in the decision Re Lehndorff General Partner Ltd.8 and quoted extensively in the Application decision by Justice Conway who emphasized that “the general partner has sole control over the property and business of the limited partnership,” while “limited partners do not have any “independent” ownership rights in the property of the limited partnership.”9
Using this description of limited partnerships as a guide, Justice Conway summarized the ownership of property in a limited partnership as follows:
- Limited partnership property can only be held by the general partner. Assignment of a lease cannot be to the limited partnership – it must be to the general partner.
- The general partner does not simply acquire legal title, but has control over the property. The limited partner is a passive investor that is restricted from controlling or managing the business. If the limited partner were to participate in the control or management of the business, it would jeopardize its limited partnership status.
- The general partner is solely liable for completing all contractual obligations, including rental payments. Limited partners have no such liability.10
Given these findings regarding limited partnerships, Justice Conway found that the Leases would be assigned to HBC in its capacity as general partner, and found that HBC as general partner would be controlled by the same person or persons that control HBC as commercial tenant. Accordingly, Justice Conway found that the assignments were permissible without Oxford’s consent.
“The Court Just Doesn’t Get the Commercial Reality” – Oxford’s Position
Even though HBC as general partner would hold legal title to the Leases, it was Oxford’s view that the structure would pose a serious issue for most commercial landlords. A tenant can theoretically transfer its leasehold interest in one of two ways – by selling all of its shares, or by entering into an assignment or sublease for the specific property. The vast majority of commercial leases, including the Leases in this case, include restrictions on both of these actions. This is because landlords will generally conduct due diligence before entering into commercial lease agreements in order to satisfy themselves as to the strength of the financial covenant of the prospective tenant, as well as its experience and success as an operator of the business to be conducted in its premises. In the absence of restrictions in a lease reserving the landlord’s right to approve a transfer to another entity (by way of asset or share sale), the landlord would have no control over the identity of its tenant.
In advancing its argument during the appeal, Oxford maintained that the court below had ignored the commercial reality of the RioCan-HBC transaction. Oxford and RioCan are direct competitors – they both own shopping centres, many of which market to the same set of large retail tenants. HBC as a commercial tenant has common interests with its landlord (Oxford) in that both aim to increase traffic so that the mall can thrive. In contrast, Oxford felt that if the Second LP (and therefore RioCan) had any control or influence over the Leases, it would attempt to draw prospective tenants to RioCan’s competing shopping centres. Oxford was also concerned that RioCan might obtain information about Oxford’s operations at the relevant properties that would not otherwise be available to the public.
A “Puppet” or “Sham Trustee” – Oxford’s Position
The concerns expressed by Oxford were augmented by the fact that the partnership agreement governing the Second LP requires HBC as general partner to consult with RioCan before making major decisions concerning the Leases. Pursuant to the Partnership Agreement, HBC as general partner may not take any of the following actions without authorization by special resolution from the limited partners:
- Sell or assign the Leases;
- Enter into any financing secured by the Leases;
- Decline to exercise an extension option or renewal of the Leases; or
- Amend, terminate, or surrender the Leases.
Oxford argued that these requirements caused HBC as general partner to assume the role of a “puppet” or “sham trustee” for the Second LP. HBC as general partner would, in Oxford’s submission, yield control to the joint venture and merely implement the decisions made by HBC and RioCan as limited partners. In response, HBC noted that as the general partner, it would maintain day-to-day decision making power and manage operations, causing its role to be significantly broader than that of a “puppet”. While HBC agreed that major decisions would be subject to a special resolution of the limited partners, it submitted that “control” would remain in the hands of the general partner. HBC argued that legal title can only be pierced if there is some basis in law to do so – otherwise, beneficial ownership structures would be of no utility. Nothing in this case, according to HBC, was sufficient to warrant such an intrusion upon the property rights of the general partner.
HBC also pointed out that it would be a participant in the joint venture with RioCan regardless of whether or not it was permitted to assign the Leases to the Second LP. Further, HBC was free to consult with RioCan or any other party before making business decisions concerning the Leases. In response, Oxford pointed to the fact that while HBC may have been free to discuss these matters with RioCan in the past, it was not obligated to do so. Under the proposed structure, RioCan’s express consent would be required for amendments to the Leases, and Oxford submitted that this change was significant.
Oxford’s submission on this issue was expressly rejected by Justice Conway, who emphasized that a limited partner is, by its very nature, a passive investor. In an unequivocal conclusion, Justice Conway held that “Oxford overstates the operational involvement that the limited partner (and indirectly RioCan) can and will have by virtue of these veto rights.”11 The Court of Appeal agreed, finding that “based on the unique legal nature of the limited partnership structure and the role played by the general partner, the Leases will be assigned to HBC, as general partner.”12 The Court went on to note that “the general partner is solely liable for all payments under the contract and performance of all obligations thereunder. The limited partners have no such liability. In this case, once the Leases are assigned, the legal relationship will continue to be between the Landlords and HBC. There will be no relationship between the Landlords and the limited partner.”13
The Role of Beneficial Interest
Throughout the appeal, Oxford maintained that an assignment significantly altering a beneficial interest in a lease constitutes a change in “control” over that lease. Much was made of the fact that the limited partner of the Second LP, being the First LP that is jointly owned by HBC and RioCan, has a 99.9999% ownership interest in the Second LP. In response, HBC submitted that the beneficial interest of the limited partner is only a passive financial benefit – 99.9999% ownership simply translates to 99.9999% of the rent from subtenants, not 99.9999% of the decision-making power.
The interpretation that Oxford advanced, being that an alteration in beneficial ownership of the entity holding the Leases would result in a change of control over the tenant, conflated two separate concepts. While the restrictions on assignment prohibited changes in control of the tenant, they did not expressly restrict changes in beneficial control of the Leases. The fact remained that legal title to the Leases would continue to vest in HBC, and there has been no change in control of HBC – it remained controlled by its shareholders. Extending the restriction on assignment to include changes in beneficial ownership interest would have required the court to interpret the clause in a novel manner.
On appeal, Oxford attempted to avert this conclusion by noting that the Leases did not specify that an “assignment” related to an assignment of legal title only. Instead, Oxford suggested that an assignment of beneficial interest may have also been captured by the language prohibiting assignments. HBC responded that it would be highly unusual for the clause to be interpreted as Oxford suggested, and maintained that the court should not take the unfamiliar step of holding “assignment” to mean anything other than assignment of legal title. The Court of Appeal, agreeing with HBC, stated that “what Oxford characterizes as the “beneficial” or “effective” ownership of the Leases cannot direct the analysis”.14
Reasonableness and Consent
Though she found that consent was not required, Justice Conway also addressed the alternative argument that Oxford unreasonably withheld consent to the transfers. Section 23(2) of the Commercial Tenancies Act provides that, unless the lease explicitly provides otherwise, the landlord may not unreasonably withhold consent to an assignment or sublease.
In this case, one of the Leases (for space in Square One Shopping Centre) explicitly allowed the landlord to withhold consent arbitrarily. However, for the other two Leases, consent was unreasonably withheld. This finding was based on the fact that HBC as commercial tenant would continue to operate the stores, remain liable under the Leases, and maintain control over decision-making.15
The Court of Appeal did not consider alternate arguments regarding reasonableness and consent. Having found that consent was not required, the Court held that addressing those grounds was unnecessary.
Practical Considerations Moving Forward
Given the Court of Appeal’s determination on the issue of control, it may now be prudent for commercial landlords to alter their forms of lease by adding a provision that specifically restricts not only changes in control, but also changes in beneficial ownership. Without such a restriction, landlords will continue to face the practical concerns expressed by Oxford in its refusal to grant consent. How and to what extent the ruling in this case could affect other commercial transactions is yet to be determined.