The Issue

A tenant fills out a rental application form and submits it to the landlord with a deposit. However, before the tenancy is to begin, the tenant backs out and refuses to sign a lease. Can the tenant get the deposit back?

Answer

Yes, depending on how the rental application was worded.

The Residential Tenancies Act, 2006 (the “RTA”) allows a landlord to obtain and retain a deposit in very limited circumstances. A recent decision from the Ontario Court of Appeal demonstrates just how limited these circumstances truly are.

The facts of Musilla v. Avcan Management Inc., 2011 ONCA 502 (CanLII) are not extraordinary. Sarah Musilla applied to rent a unit in one of Avcan Management Inc.’s residential complexes. In August 2007, Ms. Musilla filled out one of Avcan’s standard rental application forms and submitted it to Avcan along with a cheque for the equivalent of one month’s rent. Avcan accepted Ms. Musilla’s rental application and asked Ms. Musilla to contact the building’s superintendent to sign a lease for her rental unit prior to taking possession. Ms. Musilla’s tenancy was to commence on November 1, 2007.

However, six weeks before her tenancy was to commence, Ms. Musilla wrote to Avcan stating that she would not sign the lease and requesting that her cheque be returned. Avcan refused to return the cheque. Avcan attempted to find a new tenant, but was unable to secure one until January 1, 2008.

Ms. Musilla brought an application before the Landlord and Tenant Board, seeking the return of her money. She relied upon subsection 107(1) of the RTA, which provides that a landlord “...shall repay the amount received as a rent deposit in respect of a rental unit if vacant possession of the rental unit is not given to the prospective tenant.” Ms. Musilla asserted that she was entitled to a refund because she had not taken possession of the rental unit – regardless of the reason why she had not taken possession.

The Board disagreed, holding that a tenant cannot unilaterally terminate a tenancy prior to taking possession and then seek to have a deposit returned. As Avcan had not prevented Ms. Musilla from taking possession, Ms. Musilla’s deposit was deemed to have been forfeited. On appeal, the Ontario Divisional Court agreed with the Landlord and Tenant Board.

Ms. Musilla further appealed to the Ontario Court of Appeal, again arguing that she was entitled to a refund pursuant to s. 107(1) because she had not come into possession of the rental unit. The Court of Appeal agreed with the Board and the Divisional Court on how subsection 107(1) is to be interpreted, with one caveat – if a landlord is subsequently able to rent the unit without suffering any loss of rent, the deposit must be returned. A landlord cannot realize “double payment” by use of a previously paid deposit.

The Court of Appeal then moved on to consider whether the cheque provided by Ms. Musilla really was a “rent” or “security” deposit. The acceptance of Ms. Musilla’s rental application by Avcan had not actually create a lease. This was confirmed by the words of Avcan’s rental application form, which contemplates that an accepted prospective tenant will thereafter enter into a lease prior to taking possession of the rental unit. The money paid with the rental application would, upon entering into the lease, be used towards the payment of the last month’s rent. Pursuant to section 106 of the RTA, payment of the last month’s rent is the only circumstance in which a landlord can seek a “security deposit.”

In Ms. Musilla’s case, she did not execute a lease. Technically speaking, there was no tenancy and therefore there was no “last month’s rent” to which the “deposit” could be applied. Further, Avcan was not authorized by the RTA to keep Ms. Musilla’s money as a forfeiture penalty for failing to enter into a lease. In the Court of Appeal’s opinion, Avcan had no lawful authority to retain Ms. Musilla’s money. The full amount was ordered to be repaid.

The bar to Avcan’s retention of Ms. Musilla’s “deposit” appears to have arisen from Avcan’s own rental application form. The form contemplated a second step – that the prospective tenant will actually become a “tenant” by entering into a lease. Only once a lease is entered into would Ms. Musilla’s money become a “security deposit” pursuant to section 105 of the RTA. As Ms. Musilla had not taken that second step, she was entitled to the return of her money.

The Court of Appeal’s decision has the potential to create significant administrative difficulty. Rental application forms are used as a means of pre-screening potential tenants. Potential tenants are asked to provide a deposit with their applications to (a) demonstrate their bona fides in applying to rent a unit, (b) incentivize the landlord into holding the prospective tenant’s desired unit and (c) secure the tenant’s future performance. Removing deposits from the rental application process (or at least delaying deposit collection until the lease is entered into) may not be practical for either the tenant or the landlord.

It will be interesting to follow the fallout from the Court of Appeal’s decision. Prospective tenants will undoubtedly assert that they are now entitled to the return of their deposits in all situations where they do not proceed with possession of the rental unit. However, the Court of Appeal certainly did not go that far. Instead, the Court of Appeal’s decision applies only to those cases where it is not clear whether a deposit may be returned if a lease is not entered into. All landlords should turn their minds to their own rental application forms to ensure this issue is not systemic.