In 2177 23rd Avenue Holdings v. Pival International inc. (2025 QCCA 19) dated January 9, 2025, the Quebec Court of Appeal rendered an enlightening decision on the obligation of a landlord to negotiate the terms and conditions of a renewal further to the tenant’s exercise of its renewal option under a commercial lease.
The Facts
The lease in question included a renewal option in favour of the tenant, the terms of which are not uncommon. More specifically, the tenant had to provide written notice of the exercise of its option to the landlord within a certain delay, and the rent for the renewal term was to be negotiated between the parties during a 60-day period after the tenant’s exercise of the renewal option. The rent for the renewal period was to be the market rent for a similar term, in a similar building, in the same area for a comparable use. There was no arbitration provision and if the parties failed to agree upon the market rent within the 60 days, the option to renew would be null and void.
While the notice to renew was given verbally (and not in writing) by the tenant to the landlord, the landlord nonetheless made a renewal proposal to the tenant for the renewal term, which proposal was made after the 60-day period of being verbally advised by the tenant of its decision to renew. A second proposal was then sent by the landlord to the tenant three weeks after the first proposal. The second proposal included a caveat to the effect that it was subject to approval by the landlord’s management and that the proposal did not bind the parties until such time as the terms of the renewal were agreed to in writing by both parties.
A little over one month later, and after discussions between the tenant and a representative of a potential purchaser of the building (who had the right to approve renewals), the tenant was convinced the second proposal would not be accepted by the landlord’s management. The tenant consequently elected to advise the landlord that it had accepted the second proposal. Two days later, the landlord confirmed it did not accept the terms of the second proposal.
After some back and forth between the tenant and landlord where the tenant accused the landlord of walking back on its own offer and the landlord advising the tenant that it was willing to consider different rents for the renewal period, the building in which the premises were situated was sold. The new owner then provided the tenant with supporting market information justifying its latest proposal and invited the tenant to provide its own similar information.
The tenant instead decided to institute legal proceedings to require the landlord to stand by the terms of its second proposal.
Court of First Instance
The Superior Court concluded that the tenant benefited from an option to renew (and not a preferential right) and that reference to a market rent was determinable. While the Court did not believe the tenant’s acceptance of the landlord’s second proposal was binding upon the landlord, it did rule that the landlord acted in bad faith when negotiating the renewal rent. The judge ordered the parties back to the negotiating table to determine the market rent for the renewal period.
Court of Appeal Decision
The Court of Appel addressed three questions in order to render its judgment:
- Did the second lease renewal proposal made by the landlord constitute a binding agreement once accepted by the tenant?
The Court of Appeal agreed with the trial judge in that the second proposal did not bind the landlord. Despite arguments brought forth by the tenant relating to the start date of the 60 day period to agree upon the lease terms, as well as the tenant’s view that the caveats in the second proposal were too vague to be enforceable, the Court concluded that it was normal course for the landlord to include such qualifications in a proposal and that given the materiality of the lease in question, it was reasonable for the proposal to be subject to the approval of the landlord’s management. The Court of Appeal also did not question the trial judge’s determination that the landlord was free to submit the second proposal to the potential purchaser of the building for approval.
- Is the option clause in the lease a true option or a preferential right?
The Court of Appeal sided in favour of the landlord in concluding that the option provision in the lease was not a binding agreement to renew, but rather an invitation to negotiate the rent for the renewal period. Unlike many renewal clauses which either give a precise formula of how to determine the rent or refer to binding arbitration in case the parties are unable to agree upon the rent, the Court was of the view that while the renewal clause in this case did provide some overriding guidelines on what the renewal rent should be, the parties had to negotiate and agree upon such rent. The deciding factor for the Court was that the clause in this case expressly provided that if the parties were unable to agree upon the rent within a specified period, the option to renew was null and void.
- Did the landlord breach its obligation to act in good faith when negotiating the renewal rent?
The Court concluded that the landlord did not act in bad baith when negotiating the rent for the renewal period. In a victory for the freedom of contract principle, the Court highlights that the obligation to negotiate in good faith does not impose an obligation to arrive at a negotiated settlement. Failure to agree does not automatically equate to acting in bad faith. The Court found that the landlord’s rent proposals after the second proposal were reasonable and based on market information. The tenant’s refusal to entertain discussions with the landlord after the second proposal did not play in its favour and the landlord’s repeated attempts to re-engage the tenant were seen by the Court as a demonstration of its good faith.
The Court interestingly also questions the trial judge’s ruling for the parties to go back to the negotiating table. While the Court of Appeal does not render a definitive decision on this point, it casts serious doubt of its legality.
Conclusion
This decision will likely be seen as a victory for landlords and highlights the importance of providing a consequence resulting from the failure of a landlord and tenant agreeing upon a renewal rent. Whether it be the nullity of the option right itself, or the determination by a third party arbitrator to establish the rent in order to settle the dispute, it is of utmost importance to specify in a renewal clause what will happen if the parties are unable to agree upon the rent.
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