"If you look after the pennies, the dollars will look after themselves." J. Paul Getty
In an industry where profit margins can be tight, all additional costs can reduce the bottom line to retailers. While location is extremely important to the success of a retail store, the costs involved in a commercial lease can be quite high. One of the most significant negotiations between a landlord and retailer is the minimum rent payable; additional rent provisions in a lease are not often given the same level of attention. This article will summarize these additional rent considerations and identify how they can affect the profitability of your business.
Payment of additional rent
Most retail lease forms require payment of additional rent (or at least, operating costs and taxes) based on estimates determined by the landlord. Generally, at the beginning of its fiscal period, the landlord will estimate the additional rent for the year and then have each tenant pay 1/12 of its share every month. Paying additional rent based on monthly estimates can be beneficial to both parties, as the landlord will have funds available to pay expenses when they come due and the retailer will have certainty regarding its monthly lease expenses.
Adjustments of additional rent
When items of additional rent are paid based on estimates, annual reconciliations need to be completed to determine whether the retailer paid too much or too little. If the retailer has overpaid, it will want annual reconciliations to be completed as quickly as possible so that it can be credited with any overpayment (particularly since landlords will not generally agree to pay interest on such amounts).
In drafting the adjustment provisions, landlords will want as much flexibility as possible and the retailer will want as much certainty as possible. From a retailer's perspective, the following issues should be considered when negotiating these clauses:
- Has the landlord provided a covenant to complete an annual reconciliation?
- When is the landlord required to complete the reconciliation?
- What is the landlord required to deliver at the end of the fiscal period (i.e. will an audited statement be provided, a statement signed by the landlord’s CFO, or is it only required to provide a statement prepared by a property manager or lease administrator)?
Some of these issues were discussed in Ayerswood Development Corporation v. Western Proresp Inc.(2011 ONSC 1399) (Ayerswood), a decision of the Ontario Superior Court of Justice. In Ayerswood, a claim was brought by a landlord for a large adjustment in respect of operating costs and taxes. The lease provided that operating costs could be estimated by the landlord for a "period" and then went on to say: “As soon as practicable after the end of such period, the Landlord shall advise the tenant of the actual amounts for such period and, if necessary, an adjustment shall be made between the parties" (paragraph 24). This language is not unusual, and even though it did not say that statements would be delivered annually, the tenant likely expected that there would be annual adjustments. The landlord did not adjust for any “periods” during the term, and completed one adjustment after the expiry of the term and sent a bill to the tenant for CA$42,778.00. The tenant argued that it was not liable for the adjustment since the landlord did not bring its claim "as soon as practicable." The landlord’s position was that "period" was not defined and it could use a six-year period as the "period." Surprisingly, the Court agreed with the landlord and noted that the adjustment was made at the end of a "period" and that “[i]f the parties had wished to define the period, presumably they would have included such a definition in the lease" (paragraph 28).
In light of this decision, it would be wise to define "period" or to specify a time frame within which reconciliations must be completed (standard periods range anywhere from 90 to 180 days after the expiry of each calendar year). By defining the period and having a fixed date by which the reconciliation must be completed, it is clear when a landlord would be in breach of its obligations and, if necessary, a retailer could commence a claim.
Even when there are clear covenants on a landlord to perform adjustments, some landlords are fairly laidback about these obligations. Retailers should consider negotiating a right to suspend the obligation to pay any increase in additional rent estimates until the reconciliation for the prior year is completed to ensure the landlord has incentive to complete reconciliations in a timely manner.
Verification of additional rent
A prudent retailer will want to ensure that it has rights under its lease to verify any amounts charged to it. Many landlord reconciliation statements only summarize what is owed by the retailer and do not contain sufficient information to allow it to independently verify that the costs charged to it are in accordance with the lease. To ensure that it can verify the appropriateness of the costs charged to it, retailers will try to negotiate the following into their leases:
- The obligation to deliver detailed statements that reflect the various exclusions and/or deductions contained in the lease (not a statement prepared based on the landlord’s standard lease form).
- The right to request back-up information, including copies of invoices, receipts and records relating to amounts charged to the retailer.
- The right to audit or review the landlord’s books and records relating to additional rent.
Landlords generally prefer to avoid granting these rights because of the nuisance factor so when they do, these rights will likely be subject to strict conditions. Common conditions include limiting the number of times a tenant can make such requests and the time period within which a tenant could make the request (i.e. the tenant can request back-up information once per year within 60 days of receiving the landlord’s annual statement).
If a lease does not provide a tenant with a right to back-up information or an audit, it can be difficult for a tenant to verify costs charged to it. While it is best to negotiate these rights in the lease, there is some case law which suggests that, in certain circumstances, these rights may be implied into a lease. The tenant in 663579 Ontario Ltd. v. First Choice Haircutters Ltd.  O.J. No. 1122 (First Choice), disputed some of the items included by the landlord in operating costs. The Court held that the tenant was entitled to review back-up documents to verify the costs charged to it. In paragraph 38, the Court states that the “landlord has a clear responsibility to afford the tenant a reasonable opportunity, if requested, by the tenant, of examining these invoices, bills and vouchers claimed as operating expenses”. In Loyaltyone Inc. v. The Cadillac Fairview Corporation Limited 2009 CanLII 19935 (ONSC) (Loyaltyone), the landlord requested an order to strike a paragraph in the tenant’s claim which sought to require the landlord to provide the tenant with back-up information for additional rent. The landlord’s motion was dismissed because it was not “plain and obvious on the basis of settled law,” that the tenant’s claim could not succeed (paragraph 4). Referring to the First Choice case, the Court noted that it supported the position that a landlord “can be obliged, whether as a matter of contract or good faith and fair dealing to produce the documentation sought” (paragraph 4). In the American case, P.V. Properties, Inc. v. Rock Creek Village Associates Limited 77 Md. App. 77; 549 A.2d 403; 1988 Md. App LEXIS 205 (P.V. Properties) (also cited in Loyaltyone), the landlord refused to provide the tenant with itemized operating costs and the tenant asked the Court to provide it with this information so that it could verify the charges. The Court found in favour of the tenant and held that the “obligation of good faith and cooperation implied in every contract gives rise to the implied requirement on the part of the landlord to disclose its cost data and the basis upon which the tenant’s common area maintenance liability was computed” (page 5).
While detailed information regarding additional rent could be obtained through litigation, this is not a practical means of verifying that costs have been properly charged to a retailer. When the landlord in P.V. Properties made this suggestion, the Court responded that this would be “… a waste of both the court's and the litigants' time and expense” (page 7).
Limitation periods and overcharges of additional rent
Another issue to consider with respect to additional rent adjustments relates to limitation periods. In Ontario, the Limitations Act, 2002 (S.O. 2002, c. 24, Sch. B) (the Limitations Act) deals with limitation periods not affecting real property. The Real Property Limitations Act (R.S.O. 1990 c.L.15) (RPLA) deals exclusively with real property. The Limitations Act does not apply to proceedings to which the RPLA applies.
Section 17(1) of the RPLA deals specifically with arrears of rent (providing a six-year limitation period) but does not address overcharges of rent by a landlord. As it is not specifically addressed by the RPLA, the generally accepted view (and prudent approach to preserve claims) is that the operative limitation period to bring a claim for repayment of an overcharge of rent is two years, pursuant to Section 4 of the Limitations Act. The recent decision in Pickering Square Inc. v. Trillium College Inc. (2014 ONSC 2629) (Pickering Square), supports this position. In Pickering Square, the Landlord claimed liquidated damages due to the tenant's failure to continuously operate. Once the tenant vacated the premises, it never re-occupied the premises; however, it did continue to pay rent until the expiry of the lease. After the lease expired (and years after the tenant vacated the premises), the landlord commenced an action against the tenant. The tenant argued that the claim was statute-barred in part because of the two-year limitation period under the Limitations Act. The landlord argued that the RPLA would apply because its claims were for rent. The Court rejected the landlord’s argument and held that “rent” within the meaning of Section 17 of the RPLA, means “the payment due under a lease between a tenant and a landlord as compensation for the use of land and premises” and the liquidated damages claimed were not “rent” (regardless of what the lease said).
Although there is still some uncertainty regarding which act would apply in the case of a tenant’s claim for overpayment of additional rent, Pickering Square supports the position that courts are going to narrowly apply the RPLA (which is consistent with the legislative intention to create one limitation period). While this may sound unfair (since a landlord has six years to bring a claim for arrears while a tenant only has two years to claim an overpayment of rent), the legislation (and the recent case law) does not appear to support any other position.
Discoverability of a claim
Assuming that the two-year limitation period in the Limitations Act applies to an overcharge of additional rent, the two-year clock starts running on the date that a claim is discovered. Section 5(1) of the Limitations Act provides that a claim is not discovered until a plaintiff knew or reasonably should have known that the loss or damage occurred.
To this author’s knowledge, the question of when a claim for an overcharge under a lease has been discovered has not been addressed in any reported decision. However, it is likely that a court would consider the following:
- What obligations are contained in the lease regarding the delivery of year-end statements by the landlord?
- If the landlord failed to deliver statements, did the tenant request them?
- What was the level of detail in the statements? Was back-up information requested?
- What are the retailer's standard practices with respect to year-end statements? Are procedures in place to review and verify the accuracy of the statements?
- What information was given regarding the estimates?
- Were the amounts owing for a particular year significantly more than historical amounts charged?
If statements are delivered, but the landlord has been improperly passing costs through to the tenant, at what point is the tenant considered to have discovered it has a claim for overpayment? This could be as early as the date the landlord delivers an incorrect statement. However, this assumes the statement provided sufficient detail for the tenant to identify the overcharge; if not, then there is an argument that the tenant could not discover until further detail is provided.
If no statements are delivered, then at what point would a tenant “discover” that it has been overpaying? Arguably, sophisticated retailers expect yearly adjustments so it would be prudent practice to demand them if they are not delivered. Failure to deliver a year-end statement when required would be a breach and the limitation period for any claims in respect of such breach would commence on the date that the landlord failed to deliver the statement. However, the limitation period for a claim for overpaid rent could not reasonably be expected to be discovered if the tenant has not received the statement.
Retailers should ensure that they have established practices in place which allow them to discover claims in a timely manner and, if necessary, to commence proceedings within two years of discovery. Ultimately, any savings or recovery of overpayments in respect of additional rent will improve the tenant's bottom line.