REVALUATION LEASES:

WHAT WILL THE RENT BE,

IF ANY?

Prepared for the Appraisal Institute of Canada

Moncton, New Brunswick

June 10, 2011

Thompson Dorfman Sweatman LLP

Barristers & Solicitors

201 Portage Avenue, Suite 2200

Winnipeg, Manitoba

R3B 3L3

Antoine F. Hacault

Tel. (204) 934-2513

Fax (204) 934-0530

afh@tdslaw.com

© Antoine F. Hacault

TABLE OF CONTENTS

Page

INTRODUCTION......................................................................................................................... 1

1. ROLE OF THE APPRAISER ......................................................................................... 2

2. RENEWAL OR EXTENSION ........................................................................................ 3

3. CERTAINTY..................................................................................................................... 5

4. MINIMUM RENT FOR THE RENEWAL TERM ....................................................... 8

5. FAIR MARKET VALUE ............................................................................................... 10

6. SUBJECTIVE OR OBJECTIVE TEST ....................................................................... 15

7. ARBITRATION, OR “BASEBALL” ARBITRATION .............................................. 24

8. FAIR AND EQUITABLE IN THE OPINION OF THE LESSOR ............................ 24

9. MEDIATION................................................................................................................... 26

10. OTHER PROCESSES ................................................................................................ 27

CONCLUSION ........................................................................................................................... 28

APPENDIX A ......................................................................................................................... 2

INTRODUCTION

This paper is intended to summarize the Courts’ and arbitrators’ treatment of rent

renewal clauses in Revaluation Leases. When are they valid? How are they interpreted? Appraisers

are called on to provide valuations for Revaluation Leases. On occasion, however, courts have found

lease renewal provisions to be invalid and unenforceable because they lack essential terms.

Typically, the rent to be paid on Revaluation Lease is negotiated between the landlord

and the tenant, based on their perceptions of the current market rent.1 However, there are cases

where the parties cannot reach an agreement, in which case the lease will often provide for

mediation, arbitration, or some other mechanism for determining the rent, including a “baseball”

arbitration, which will be discussed in more detail in this paper.2

The appraiser can play a role in assisting lawyers understand how to draft an

appropriate renewal clause. For example, most lawyers will not think of specifying an effective date.

The failure to specify an effective date may create uncertainty and an unnecessary area of dispute in a

rising or falling market.

In the circumstance where the lease provides no mechanism to set the rent, but

provides a formula such as “fair market rent” for the renewal term, a Court may supply the

mechanism and an action may be brought to have the rent determined by the court.3

The question then, becomes what is the proper framework for an appropriate analysis

in interpreting a renewal provision in a Revaluation lease? This paper focuses on the applicable

principles and discusses a number of cases which have provided helpful guidance and interpretation

of these renewal clauses.

1 Richard Olson, “A Commercial Tenancy Handbook” (2007) Volume 1, at 5-5 [“Olson”].

2 Ibid. at 5-5.

3 Ibid.

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1. ROLE OF THE APPRAISER

It is important to understand the retainer which the appraiser is accepting when

dealing with renewal clauses.

If an appraiser accepts an Appraisal assignment, CUSPAP Appraisal Standards apply.

The appraiser benefits from the insurance coverage in accordance with its terms and conditions. In

Section 3 of the March 10, 2010 version of the Appraisal Institute Professional Practice Seminar

Participant Manual, there is a summary of the Professional Liability Insurance coverage. The terms

of the Policy will govern.

Coverage is with respect to what is defined as “Professional Services”. The potential

issue is whether arbitration services, as opposed to valuation services falls within the definition of

Professional Service.

If the renewal clause requires the landlord and the tenant to choose an AACI to apply

the rent renewal formula and determine the rent to be paid, the appraiser may be considered to be

acting as an arbitrator - not as an appraiser. This may give rise to errors and omissions insurance

coverage issues. At the time of preparing this paper, the view of persons in the ACI for coverage

were of the view that coverage would be granted to an AACI acting as an arbitrator for valuation

purposes.

If the landlord and tenant are each submitting to the appraiser their comparables and

reasons for which they submit their position is correct, the role of the appraiser becomes that of a

decision maker. This is even clearer if the landlord and the tenant each retain AAIC’s who prepare

appraisals to submit to the appraiser designated as the decision maker. The Appraisal Institute of

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Canada’s insurance plan will probably cover one of its members who engages in an arbitration role.

It would be prudent to contact the Appraisal Institute to clarify the issue of coverage before taking on

any assignment which has the indicia of taking on the role of an arbitrator.

Essentially, a “valuation” is a determination of the rent in issue by a third party, the

“valuer” or the “appraiser”, hired jointly by the landlord and tenant who agree to abide by the

decision of the valuer. The difference between a “valuation” and an “arbitration” is that the “valuer”

relies on his or her own skill and expertise to determine the market rent without relying on

submissions and evidence put before him or her by the parties.4 A valuer may request information,

but will conduct the process as an appraisal assignment. It is important to keep in mind that a

valuation is not an arbitration, and therefore if the hired person is required to do more than simply

determine a value, the function will be that of an arbitrator, and not a valuer. Further, a valuation is

not an arbitration and is therefore not subject to review by the Court on an appeal. However, a

valuation may be set aside if it can be shown that there was a reasonable apprehension of bias on the

part of the valuer. Additionally, a valuer may be sued in negligence.5

2. RENEWAL OR EXTENSION

There are two different types of revaluation leases. The first is a Renewal Lease and

the second is an Extension Lease. What is the difference and what is the effect on a valuation being

conducted by you?

A revaluation lease which is renewed for an additional term beyond the original term

ends with the original term and the renewal creates a new lease. The renewal operates as a surrender

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of the original lease and a grant of a new lease.

A revaluation lease which is extended continues the original lease without

interruption6.

Often leases contain clauses which do not run with the land. Those clauses will not

continue to be binding in a renewal lease unless specifically set out in the renewal option that they

do.

Examples include:

(a) a right of refusal on adjoining space;

(b) a first right of refusal to purchase the property;

(c) a tenant which uses or creates potential contaminants and covenanted to maintain and

repair the premises;

(d) the inclusion or exclusion of tenant’s improvements in determining the rent

may be personal to the Tenant and may not run with the land and will not automatically be

included. A clause providing that for an automatic renewal on the same terms and conditions has

been found to only apply to the renewal of the lease and not to the first right of refusal7.

4 Supra note 2 at 5-6.

5 Ibid. at 5-6 - 5-7.

6 Avlor Investments Ltd. v. J.K. Children’s Wear Inc. (1991), 85 D.L.R. (4

th) 239; (1991), 6 O.R. (3

rd) 225 (Ont. Ct. (Gen.

Div.)) 7 Budget Car Rentals Toronto Ltd. v. Petro-Canada Inc. (1989), 60 D.L.R. (4

th) 751 (Ont. C.A.)

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3. CERTAINTY

Courts have found lease renewal provisions to be invalid and unenforceable because

they lack essential terms, and are therefore void for uncertainty. Thus, in order to be valid, a

covenant in a lease which provides for a renewal of the term must designate with reasonable

certainty the date of commencement and the duration of the renewal term to be granted. There must

also be a formula. An agreement to agree is not enforceable.

Thus, a lease which provides that the “rent shall be as agreed upon between the

parties” will not be enforceable8.

A lease which provides that rent for a part of the lease is to be determined at "current

market rates" is certain and enforceable9. A renewal clause which provides that renewal rent shall be

at the “then prevailing market rates” is not void for uncertainty10

What if the lease reads as follows:

18.08 - That the Lessee shall, in the event that there shall have been no

substantial default hereunder, have the option to extend this lease for

an additional term of five (5) years from the end of the original term, at

a rental to be agreed upon by the Lessor and the Lessee, as being the

fair market rental for the demised premises when compared to other

buildings of comparable design, age, location and condition, the

other terms, conditions and covenants to be the same as herein save

and except the right of further renewal. The Lessee may exercise this

option and extend this lease for the said additional term of five (5)

years by giving to the Lessor written notice by registered mail at least

three (3) months prior to the end of the term."

The Court held the renewal option was void for uncertainty11

8 Geary v. Clifton Co. Ltd., [1928] 3 D.L.R. 64 (Ont. H.C.J.)

9 Horse and Carriage Inn Ltd. v. Baron (1975), 53 D.L.R. (3d) 426 (B.C.S.C.)

10 Mustard Seed (Calgary) Street Ministry Society v. Century Services Inc., 2009 CarswellAlta 572 (Alta. Q.B.)

11 Hirex Holdings Ltd. v. Chrysler Canada Ltd./ Chrysler Canada Ltée (1991), 16 R.P.R. (2d) 154 (B.C.S.C.)

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The following rent renewal clause was held to be unenforceable:

If the Lessee duly and regularly pays the said rent and performs

each and every of the covenants, conditions, provisos and

agreements herein contained and on the part of the Lessee to be

paid and performed punctually and in accordance with the

provisions of this lease, the Lessor shall, at the expiration of the

said term, upon receiving Notice from the Lessee at least six (6)

months and not more than twelve (12) months prior to the

expiration of the said term grant to the Lessee, at the expense of the

Lessee, a renewal lease of the demised premises for a further term

of five (5) years from the expiration of the said term upon the same

terms and conditions except as to the inclusion of this clause (6.25)

and except as to the amount of rent which shall be agreed between

the parties, but shall not be less than the rent reserved hereunder.

(emphasis added)12

In Gourlay et al. v. Canadian Department Stores Ltd.,13

the Supreme Court of Canada

considered a commercial lease of certain rooms and hallways in the lessor’s building which adjoined

the lessee’s hotel. The lease provided for a renewal provision that allowed the lessees to renew the

lease “for such further term as the Lessees may require”:

It is hereby agreed that this Lease and the term hereby created shall at

the option of the Lessees be renewed (1) for such further term as

the Lessees may require the said bedrooms and the hallway for use

in connection with the said hotel, and whether used as an [sic] hotel,

boarding-house or apartment house; (2) and for such further term as

shall correspond with the term of any lease that may be given by the

said Lessees to any tenant in respect of the said hotel premises and (3)

thereafter from time to time so long as the said bedrooms may be

required for hotel, boarding-house or apartment house purposes at a

rental equivalent to one-eighth part or portion of the rental received

from time to time for the said hotel, boarding-house or apartment

house.(emphasis added)

12

Allarco v. Novelty (1982), 47 A.R. 161 (Q.B.) 13

Gourlay et al. v. Canadian Department Stores Ltd., [1933] S.C.R. 329 [“Gourlay”].

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The leased premises consisted of sixteen bedrooms and hallways in the respondent’s

building, immediately adjoining the appellants’ hotel in the Town of Lindsay, Ontario, and had, for

some years, been used in connection with the hotel. The respondent contended that the covenant was

too vague and indefinite to create a right of renewal, and that it did not give the appellant any such

right and was void for uncertainty. The appellants, on the other hand, submitted that so long as the

term of each renewal lease can be made certain at the time the lessees call for it, that is sufficient to

meet all the requirements of the law regarding certainty.

The Supreme Court stated that is well established law that, in order to be valid, a

covenant in a lease which provides for a renewal of the term must designate with reasonable

certainty the date of commencement and the duration of the renewal term to be granted. Moreover,

this certainty as to duration must appear from the express limitation of the parties or from reference

to some collateral matter, which is itself certain or capable of being made certain before the renewal

lease takes effect.

The Court held that the language used in this renewal clause, that the lessees could

renew “for such further term as the Lessees may require”, showed that the intention was to provide

for a right of renewal for such period as the lessees should need the use of the premises, and that as

there was nothing in the covenant which enabled the court to determine the duration of the lessees’

need for the premises, the renewal provision was too indefinite to be enforced, and was therefore

void for uncertainty. The Court stated that if the renewal provision had read “for such further term as

the lessees may request or demand”, it would not have contravened the rules requiring certainty,

because the duration of the term would have been made certain by the request of demand for

renewal.

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Do the parties have to enter into negotiations if the rent is to be “mutually agreed

between the Landlord and the Tenant”? Some courts have held that an agreement to agree carries

with it an obligation to negotiate in good faith and not to withhold agreement unreasonably. The

parties must use their “best efforts”. This would imply that a Landlord would not lease the premises

to another party for a rent at or below the rent offered by the Tenant. Thus if the Tenant had offered

to renew at $15.00/sq.ft triple net, the Landlord should not rent to another party for $15.00/sq.ft.

triple net.14

4. MINIMUM RENT FOR THE RENEWAL TERM

In preparing a rent review or a rent determination under a lease, it is of fundamental

importance that the appraiser be guided by the criteria set out in the lease. It may be that the

minimum rent will be applicable during the renewal term.

For example, in the Sauder School of Business course “Lease Analysis CPD 109”, the

sample Shopping Centre Lease included as Appendix A has the following clause:

111. Option to Renew

Provided that the Tenant is not in default under the terms of this

lease, the Tenant shall have the option to renew this lease for one (1)

further period of five (5) years (the “Renewal Term”) upon the same

terms and conditions as set out in this lease, save and except 1)

minimum Rent, 2) this option to renew. The Tenant may exercise this

option upon providing to the Landlord written notice to such ext3ent

not more than nine (9) months prior and not less than six (6) months

prior to the expiration of the Term. Minimum Rent during this

Renewal term shall be fair market rent for the Premises as mutually

agreed upon by the Landlord and the Tenant, but not less than the

rent payable during the last year of the Term. If the Landlord and

Tenant cannot agree on the Minimum rent for the Renewal Term

14

Empress Towers Ltd. v. Bank of Nova Scotia (1990), 50 B.C.L.R. (2d) 126, 73 D.L.R. (4th

)400 (C.A.), leave to appeal

to S.C.C. refused.

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ninety (90) days prior to the expiration of the term, the then

disagreement shall be referred to binding arbitration, under the

provisions of the Commercial Arbitration Act of B.C.

It is not uncommon for a lease to provide a minimum rent during the renewal term.15

There are three common methods used to determine the minimum rent for the first

year of the renewal term.

The first method is based on past minimum rent payments. This is the method

illustrated in the above clause taken from “Lease Analysis CPD 109”. Under this method, the new

minimum rent for the first year of the renewal term equals the minimum rent paid during the last

twelve months.

A variation might be that the new minimum rent for the first year of the renewal term

equals the minimum rent paid during the last twelve months of the original term plus one-third.16

For example, if the minimum amount paid during the last twelve months of the original term was

$9,000, then we would add that amount, with one-third of that amount: $9,000 + $3,000 = $12,000.

Therefore, the new Minimum Rent for the first year of the renewal term would be $12,000.

The second method uses a formula based on the Consumer Price Index (“CPI”)17

:

Highest Average CPI (2nd

, 3rd

, or 4th

Rental Year)

Minimum Rent x Average CPI during 1st year

Using the same amounts as the example above, if the highest average CPI was 150 (in the fourth

rental year) and the average CPI during the first rental year was 126, then the new minimum rent for

the first year of the renewal term would be computed as follows:

$9,000 x 150 ÷ 126 = $10,714.29

15

Harvey M. Haber, Q.C., “The Commercial Lease: A Practical Guide” (1999) 3rd Edition, at p. 401 [“Haber”]. 16

Ibid.

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The third method is based on the average combined minimum and percentage rent.

This method raises the new minimum rent to the average of the combined minimum rent plus the

percentage rent payable during the third and fourth rental years of the original five-year term.18

For

example, if the average combined minimum rent and percentage rent for the third rental year was

$15,920 ($9,000 + $6,920); and $15,560 for the fourth rental year ($9,000 + $6,560), then the

average combined minimum rent and percentage for these two rental years would be $15,740.

There are renewal clauses which combine all three methods in arriving at a minimum

rent.

5. FAIR MARKET VALUE

It is fairly common to see the renewal clause refer to:

- “market rent”;

- “fair market rent”.

In The Appraisal of Real Estate, (3rd

Canadian Edition), the phrase “market rent” is

defined as follows19

:

Market rent is the rental income a property would probably command

in the open market. It is indicated by the current rents that are either

paid or asked for comparable space with the same division of

expenses as of the date of the appraisal. Market rent is sometimes

referred to as economic rent.

market rent

The most probable rent that a property should bring in a competitive

and open market reflecting all conditions and restrictions of the

17

Ibid. 18

Ibid. at 409 19

The Appraisal of Real Estate, (3rd

Canadian Edition) at p. 20.9; Note, see also The Dictionary of Real Estate Appraisal

(5th

ed. Appraisal Institute) at pp. 121 and 122.

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typical lease agreement, including the rental adjustment and

revaluation, permitted uses, use restrictions, expense obligations,

term, concessions, renewal and purchase options and tenant

improvements (“TIs”)

One should always carefully analyse the lease provisions to determine:

1. Whether the current use, the highest and best use, or any use of the property is to be assumed

as appropriate;

2. Whether the tenant’s improvements are to be considered or not;

3. The date of the valuation;

4. Whether any restrictions on use are to be taken into account such as “leased to a similar

tenant”; and

5. Whether there are any special considerations to be taken into account such as any limitation

on the location or type of comparable to be considered.20

Generally, evidence of lease rates set subsequent to valuation date is not admissible in an arbitration

and should be avoided by an appraiser.21

Further, no two leases are exactly alike in all respects, and therefore, an appraiser will

likely need to make “adjustments” to the market data for:

1. The location of the comparable property;

2. Time, that is the date of the comparable lease;

3. The size of the comparable property; and

4. Other relevant terms or circumstances of the comparable lease including:

a. The use of the property;

20

Ibid. at 5-9. 21

Ibid.

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b. Restrictions on use; and

c. Tenant’s improvements.22

Moreover, the appraiser must be mindful of the terms of reference in conducting an

appraisal. For example, what are the initial instructions given to the appraiser? These instructions

generally ought to mirror the terms set out in the lease. For example the clause may provide “the fair

market rental value of the premises taking into account the rents paid for similar properties used for

the same purpose as the demised premises at the date of the renewal”. Additionally, the appraiser’s

conclusions should be compared with the statement of the terms of reference to see if they are

consistent.

In Union Properties Inc.,23

the defendant abandoned a lease and refused to pay the

rent. The plaintiff had leased the office space to the defendant for 10 years, and the defendant agreed

to pay a flat minimum rent for the first 60 months of the lease. The defendant further agreed to pay

market value for the last 60 months. The renewal provision read as follows:

It is understood and agreed that the Minimum Annual Rent

hereinabove prescribed is based upon the rate of $12.00 per square

foot of the demised premises per annum for the first sixty (60)

months of the term of this Lease, and Market Rental Value per

square foot of the demised premises per annum thereafter.

The Alberta Court of Queen’s Bench first determined whether the renewal clause was

certain. The Court stated that the determination would depend on whether the term, “Market Rental

Value”, is one that has meaning in the industry. The Court stated that this term suggests a plain

meaning of the words, a rental amount based on the value of the premises in the then current market.

The Court held that the term Market Rental Value is a clear indication of a rental amount that the

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market in question would bear assuming willing participants. Further, the Court held that the

industry is well versed in determining such rental rates, and had tested methods for such

determinations, and was capable of providing sufficiently certain ranges of values. Thus, the term

“Market Rental Value” is certain.

In Musqueam Indian Band,24

the Musqueam Indian Band (the “Band”) surrendered

approximately 40 acres of reserve land to the Crown for the purposes of leasing. The Crown

subsequently entered into an agreement with a company unrelated to the Band. The company

serviced and subdivided the land and the Crown provided the company with an individual lease for

each lot. Each lease had a 99-year term. The company then assigned the leases to individuals, who

developed the lots. The rent for the first 30 years was set out in the leases, while it was subject to

review after the first 30 years, and every 20 years after that. The leases provided that the rent payable

upon review would be fair rent for the land and indicated that an annual clear total rental

representing 6 percent of the “current land value” should be regarded as “fair rent”. When the leases

came up for review, the parties were unable to agree on the meaning of “current land value”.

The Federal Court, Trial Division held that the “current land value” should be

calculated as representing the hypothetical fee simple value of the land discounted by 50% to take

into account the long-term leasehold interest and Indian reserve features. The Federal Court of

Appeal reversed this decision and held that the current land value represented the fee simple value of

the land without the 50% reduction on account of the Indian reserve features. The leaseholders were

granted leave to appeal on the issue of the proper meaning of the phrase “current land value”. The

22

Ibid. at 5-10. 23

Union Properties Inc. v. Monenco Advisory Services Ltd., [1996] 10 W.W.R. 711 [“Union”]. 24

Musqueam Indian Band v. Glass, 2000 SCC 52, [2000] 2 S.C.R. 633 [“Musqueam”].

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Supreme Court of Canada by a majority of 5:4 allowed the appeal and restored the trial judge’s

decision.

The rent renewal clause, which was identical in each of the individual leases,

provided the following:

2(2) The rent for each year of the three succeeding twenty (20) year

periods and for the final nine (9) year period of the term hereof, shall

be a fair rent for the land negotiated immediately before the

commencement of each such period. In conducting such negotiations

the parties shall assume that, at the time of such negotiations, the

lands are

(a) unimproved land in the same state as they were on the date of this

agreement;

(b) lands to which there is public access;

(c) lands in a subdivided area, and

(d) land which is zoned for single-family residential use,

2(4) An annual clear total rental which represents six percent (6%) of

the current land value, calculated at the time of the renegotiation,

and on the basis set out in subparagraph (2) hereof, shall be regarded

as a “fair rent” for the purposes thereof.

The lessees contended that “current land value”, as used in Clause 2(4) above, means

the value of the land as it is currently held, that is, as reserve land. Conversely, the Band argued that

“current land value” referred to the value of the fee simple title to similar land, absent factors

associated with its reserve status.

The Supreme Court of Canada stated that the meanings of “land” and of “value” are

well established in law. Unless the agreement states otherwise, “land” refers to a right to receive a

good title in fee simple. In real estate law, “value” generally means the fair market value of the land,

which is based on what a seller and a buyer would pay for it on the open market. Market value

generally is the exchange value of the land, rather than its use value to the lessee. Land is valued

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without regard to the tenant’s interest in it, for the tenant’s decision not to use the land for its highest

use does not reduce the land’s exchange value. This important distinction between market value

which is the exchange value of the land, and its use value to the lessee, made it clear that the specific

terms of a lease are not relevant when determining fair market value of the bare land for a rent

review. Moreover, legal restrictions on land use, as opposed to restrictions in the lease, may affect

the market value. The Court also stated that unimproved lands means unserviced lands, not just

lands without buildings.

It is to be noted that the majority decision quotes extensively from the 1999 Canadian

Edition of The Appraisal of Real Estate.(see for example at para. 47)

6. SUBJECTIVE OR OBJECTIVE TEST

The issue is whether an objective market test should be applied to the formula or

whether a subjective test taking into account the particular circumstances of the tenant should be

retained. There can be a significant difference between the two approaches.

Some of the legal text books set out the test as follows:

Professor S.M. Waddams, in The Law of Contracts, (3rd

Ed.) at

p.27 comments:

...Further, the phrase "fair market value", rather than some such

phrase as "a price to be mutually agreed", suggests a firm

agreement at a price to be objectively determined...

8 Halsbury's Laws of England, vol.27(1), "Landlord and

Tenant", 4th

ed. (London: Butterworths, 1980) at p.253-54, para.

273, speaks to the meaning of "rental value":

273. Meaning of "rental value". Rent review clauses necessarily

require the valuer to ascertain rental value but may qualify this

expression with words, such as 'market', 'open market', 'rack', 'fair',

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'reasonable', 'best' or 'highest'; but none of these qualifications

seems to make any difference. It has been said that there is no

difference between a market rent and an open market rent; that in

the expression 'market rack rental value' the word 'market' adds

nothing to 'rack' or vice versa, and that in the commonly used

formula 'the highest rent at which the premises might reasonably be

expected to be let' the word 'highest' adds only emphasis because

the rent at which premises might reasonably be expected to be let

in the open market by a willing landlord is the highest rent

available... A fair and/or reasonable rent is the same as a

market rent in that it requires an objective assessment of the

rent which could be obtained without taking into account

consideration personal to the actual parties. The concept of a

reasonable rent differs from that of a rent which it would be

reasonable for the tenant to pay, which will let in

considerations personal to the actual parties such as whether

the tenant should or would agree to pay rent for his own

improvements.25

Definitions of “fair” and “equitable” include:

Fair: Having the qualities of impartiality and honesty; free from

prejudice, favouritism, and self interest. Just; equitable; even

handed; equal, as between conflicting interests. See also Equitable,

Reasonable.

Equitable: Just; conformable to the principles of justice and right.

Existing in equity; available or sustainable in equity, or upon the

rules and principles of equity.26

We will see however with the cases that follow that the result of the application of

this test is not always easy or consistent.

In NRI Manufacturing Inc.,27

a commercial lease provided that rent for the initial

renewal term was “fair market value” as agreed by the parties or as determined by arbitration “based

25

Note that in Commercial Leases - Options to Renew, May 2008, CLE Society of British Columbia, at p. 7.1.6, the

authors are of a contrary view and state: “A subjective rent will … arise where the rent is to be a “fair” rent or a

“reasonable” rent, without reference to “market” or other properties or types of properties. Citing Thomas Bates & Son

Ltd. v. Wyndham’s (Lingerie) Ltd., [1981] 1All E.R. 1077 (C.A.) 26

Black’s Law Dictionary (5th edition, St. Paul, Minnesota 1979) 27

NRI Manufacturing Inc. v. Gross, 1999 CarswellOnt 2523 [“NRI”].

- 17 -

on all of the relevant facts and circumstances”.

The applicable clauses read as follows:

Section 19.2 Rent for Initial Renewal Term

The Basic Rent payable for each year of the Initial Renewal Term

will be the fair market rental value of the Initial Renewal

Premises as at December 31, 1998.

For the purposes of this Section 19.2, "fair market rental value" of

the Initial Renewal Premises will be as agreed by the parties or as

determined by arbitration as provided herein, based on all

relevant facts and circumstances, but subject to the following:

(a) Such fair market rental value shall be determined as if any

Improvements to the premises in question (and not items of

maintenance) which in conformity with the provisions of the Lease

have been made by the Tenant during the Term, had not been

made;

(b) The Basic Rent for any month shall in any event not be less

than one and one-third times the deemed mortgage servicing costs

(the "Deemed Mortgage Servicing Costs") for such month as set

forth in Section 19.5 hereof; and

(c) If the Initial Renewal Option shall be exercised in respect of

one, but not both, of the Cawthra Premises and the Symington

Premises, in calculating the one and one-third times Deemed

Mortgage Servicing Costs for any month of the Initial Renewal

Term or the Second Renewal Term, the deemed mortgage principal

(the "Deemed Mortgage Principal") for such month as set forth in

Section 19.5 hereof shall be reduced by two-thirds of the amount,

net of sales commissions and costs of sale, which on the balance of

probabilities the Landlord would have received for the lands and

premises in respect of which the Initial Renewal Option was not

exercised had the Landlord sold such lands and premises for the

fair market all-cash sale value thereof as at December 31, 1998, as

agreed to by the Tenant and the Landlord or as determined by

arbitration as provided herein, and the Deemed Mortgage Servicing

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Costs for such month shall be recalculated using the parameters set

forth in section 19.5 and reduced accordingly.

. . . . .

Section 5.2 Rent After Sale

If a Sale occurs at any time during the Term, then the Basic Rent

payable for the remainder of the Term will be amended to be the

greater of:

(a) the then fair market rental value of the Leased Premises; and

(b) $666,000 per annum,

provided that in such event, EBIT Bonus Rent for the portion of the

fiscal year of the Tenant which has elapsed up to that time, shall be

calculated and shall be paid as if the then current fiscal year of the

Tenant had ended at that time.

Fair market rental value will be agreed to by the parties, failing

which the determination will be made in accordance with the

provisions of Article 21 hereof, based on all relevant facts and

circumstances.

The Divisional Court judge granted the tenant’s application for a declaration that a

portion of the lease was to be interpreted objectively, because the predominant language in the

phrase “fair market value” indicated that an objective approach was proper.

If the approach was subjective, it would require the arbitrator to take into

consideration matters specific to that specific tenant and that specific landlord such as the cost of the

tenant to dislocate and relocate, including, among other things, the cost of cleaning up the present

premises. On appeal, the Court of Appeal stated that an objective approach was appropriate and the

fair market rental value ought to be determined as if any improvements to the premises in question

(and not items of maintenance) had not been made.

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Disputes arise as to whether work and improvements done to the building or the

property of the premises ought to be factored into a rent amount on renewal. This can be a

significant issue for tenants who have made a significant amount of upgrades to the building or the

raw land during the original term. For example, if the tenant has made $500,000 of improvements

and the lease is up for renewal after 5 years, it could end up paying for the improvements twice in a

fairly short time period if the improvements are included in the rent renewal calculation.

Is the test to be applied “subjective” (i.e. based on the evidence of what the parties

intended) or “objective” (i.e. based on a reasonable person test)?

In Yonge-Elington Building Ltd.,28

the key words in the lease were “fair and proper

sum” and “exclusive of and without taking into consideration any buildings or improvements

thereon”. The case involved a 17-storey office building which was leased for an initial term of 30

years, with a right of renewal to renew for two additional terms of 30 years each. The yearly rent

was $26,018.00 for the first 13 years, and $44,650.00 for the next 17 years. The lessee was not

permitted to erect or construct any foundation, supporting column, building or structure on certain

parts of the demised lands. However, the lease required that the lessee erect on part of the demised

lands an elevated two-storey parking deck above certain lands retained by the lessor, and also

construct a parking garage. Additionally, the lease required the lessee to construct and maintain an

office building on the northeast portion of the demised lands at a cost of not less than $4 million and

of such materials approved by the lessor.

If the parties were not able to agree on a rental rate, then each party was to appoint an

arbitrator and the two arbitrators:

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“… shall meet to fix a fair and proper sum to be paid as yearly rent

for the said demised parcels of land, exclusive of and without taking

into consideration any buildings or other improvements thereon,

and the sum which shall be fixed by them… shall be the rent to be

paid by the Lessees, for and during the further term of thirty years.”

The lease further provided that if the two arbitrators could not agree on a rent, then a third arbitrator

was to be appointed and the three arbitrators should then determine the rent on the above analysis,

which occurred in this instance.

The property had been developed in three (3) phases as a fully integrated project

which limited the density and highest and best use which would be available if this integration did

not exist.

If a subjective test was applied, the property would be valued with the density actually

in use upon the Phase I lands. If the objective approach was used, the Phase I lands would be treated

as a separate free-standing parcel of land to be treated as a vacant site free of all encumbrances and

available for developments in accordance with the highest and best use of the land without

consideration of the interlocking relationships of what is actually built on the site.

The basic argument before the arbitrators, and subsequently before the Ontario Court

of Justice (General Division), was whether a subjective (the value of the parties) or objective test (the

market rent) should be taken in determining the density or square footage to be used in calculating

the rent.

The Ontario Divisional Court held:

It would appear that wherever the words used refer to “market value”

or “market rent” or “appraised value” the objective approach is to be

taken. For the words that merely refer to “rent” or “worth”, the

subjective approach is to be taken.

28

Yonge-Eglinton Building Limited (“YEBL”) v. Toronto Transit Commission (“TTC”), [1997] O.J. No. 89 [“Yonge”].

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In its analysis, the Court noted that the renewal clause in this instance did not refer to

wording such as: “as if vacant and unencumbered”, “as bare land”, “market value”, “highest and best

use”, or words to this effect which might have served as a basis for excluding consideration of even

the presence of the buildings and other improvements. The Court noted that nowhere was there any

reference to market value or appraised value. It concluded that the arbitrators were correct in using

the subjective approach. This meant what would have reasonably been considered to be fair and

proper between the parties themselves – not the market value. The Court stated that wording only

required the exclusion of the value of the improvements.

What happens when the wording does refer to “market value” and to “bare land”? In

No. 100 Sail View Ventures Ltd. v. Janwest Equities Ltd.29, the British Columbia Court of Appeal

considered the following clause:

On or before the end of the tenth year of the Term, the Base Rent

payable shall be renegotiated to a value equal to 10% of the fair

market value of the Leased Premises as bare land at the date of the

review, and the Base Rent shall be reviewed on each successive fifth

anniversary of the Term after that. If within thirty (30) days following

such anniversary dates the Landlord and the Tenant have not agreed as

to the Base Rent, the amount shall be determined by arbitration. ...

Section 6.01 of the Agreement contained the following restrictions:

The Tenant [the Petitioner herein] shall use the Leased Premises only

for the purpose of a Hotel and related hospitality businesses including

without limitation, parking, restaurants, health clubs, offices and retail

outlets and not for any other purpose or business.

The question of law before the Court was as follows:

29

No. 100 Sail View Ventures Ltd. v. Janwest Equities Ltd., 1993 CanLII 477 (BC CA)

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In calculating the fair market value of the Leased Premises as bare land

pursuant to section 4.02 of the Agreement, should the existence of the

Agreement and, in particular, section 6.01 of the Agreement restricting

the use of the Leased Premises, be considered?

After having reviewed a number of cases and having considered the lease, the Court

held:

With respect, I think that the phrase "fair market value of the Leased

Premises as bare land" must be interpreted in this case as necessarily

inferring that the valuation be done without reference to the lease

and consequently without reference to the restricted use found in

the lease. In my opinion if the parties intended to include as a factor in

the valuation of base rent the restricted use they would have expressly

said so in words that would have modified the words "bare land". I

think that to factor in the lease or the restricted use in it would result in

the landlord being denied the fair market value of the land "as bare

land".30

In Lynnwood Industrial Estates Ltd.,31

the lease provided that the rental after the first

ten year term of the sixty year term was to be set by agreement between the parties for each

subsequent five year period, and failing agreement, then by arbitration. In this case, the parties were

not able to agree on a rent amount, so the matter proceeded to arbitration. The arbitrator had to

decide whether, for the purposes of fixing the annual rent for the five-year period, the land ought to

be:

- valued as per the condition it was in when the lease was first entered into, or

` - valued as per the present conditions which included approximately $230,000 of

improvements by which the property was converted into a marina. Portions of the land had been

30

See also Fire Productions Ltd. v. Lauro 2006 BCCA 497 where the Court held that “fair market rent” required an

objective test and required the value of a tenant’s improvements to be included in the determination of rent even though

this results in the tenant paying rent on the value of its improvements but see Canadian National Railway v. Inglis Ltd.,

153 D.L.R. (4th) 291, 36 O.R. (3d) 410 (Ont. C.A.) at para. 18 where the court held: “In my view, as a general

proposition, valuations of land for the purpose of determining rent should take into account restrictions imposed by a

lessor on the use of the land unless the lease contains some provision clearly manifesting an intention that the restrictions

are not to be considered in fixing value.” 31

Attorney-General of Canada v. Lynnwood Industrial Estates Ltd., (1983) 146 D.L.R. (3d) 381 [“Lynnwood”].

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filled and adjoining water lots had been created.

The arbitrator considered whether the Lessor was entitled to a rent based in part upon

a capital value created by, and at the expense of, the Lessee.

The applicable clause was worded as follows:

THAT a review of the rent be made at the end of the first nine-year

period of the term hereby granted, ending February 28th, 1967, to

enable the parties to arrive at the rental to be fixed for the period

commencing with the eleventh year of the term hereby granted for the

ensuring [sic, ensuing] five years with a further review of rentals at

the end of each successive four year period thereafter to ascertain the

rental to be fixed for each ensuing five year period during the term of

this lease until the said lease is terminated, provided that if the rent

to be fixed for each and every five year period cannot be mutually

agreed upon between the Minister and the Lessee, the rent to be

paid shall be set by arbitration pursuant to the Arbitration Act of the

Province of British Columbia.

Counsel for the Crown argued that the lease should have so provided if the

improvements to the land itself made at the expense of the lessee were to be excluded in assessing

the rental value.

The arbitrator concluded that in the absence of a clear indication to the contrary in the

lease itself, the rental to be fixed must be “fair and appropriate as between the landlord and tenant,

having regarding to all the existing circumstances.” Thus, the arbitrator concluded that the lease rent

for the five-year renewal period ought to be based on the capitalized value of the demised land as of

the current market conditions, but assuming that land was in the same physical condition as it existed

at the commencement of the lease (i.e. as unimproved). Essentially, the arbitrator chose to determine

the rental value in the “as was” condition rather than the “as is” condition (i.e with the fill in place).

The Courts upheld the decision of the arbitrator.

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7. ARBITRATION, OR “BASEBALL” ARBITRATION

The “baseball” arbitration process was named after the salary process utilized in

professional baseball. This is a form of arbitration, held before a single arbitrator where prior to the

commencement of the hearing each party must propose the appropriate rent for the renewal term.32

After hearing evidence from both parties, the arbitrator must select one of the two rents proposed, but

may not select an amount above, below, or between either amount. The main advantage to this

approach is that it requires each party to be realistic in submitting a proposal to the arbitrator.33

In Bank of Nova Scotia,34

an arbitration clause in the lease stated that the rent would

be settled by an award of the board of arbitration, and that the award would be binding upon the

parties. Thus, the award was not subject to appellate review. The board of arbitration in this case

fixed the rent payable by the tenant during the renewal term of the lease. The tenant appealed the

award, and its appeal was dismissed. The award was not subject to appellate review as the parties

abrogated their right of appeal by means of the agreement in the lease. The absence of a right of

appeal provision in the lease confirmed that the parties did not intend the award to be subject to

appellate review. Furthermore, the Court stated that the Arbitration Act does not provide for a

statutory right of appeal except where the parties established such right by agreement.

8. FAIR AND EQUITABLE IN THE OPINION OF THE LESSOR

A rent renewal provision that provides that the rent on renewal will be determined in

32

Supra note 2 at 5-7. 33

Ibid. 34

Bank of Nova Scotia v. Span West Farms Ltd. 2003 SKQB 306 [“Bank of Nova Scotia”].

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accordance with what the lessor deems to be fair and equitable is rare. Generally, a lessee will not

have agreed to this type of renewal provision in the first place. However, this type of provision does

exist, and the courts have dealt with it accordingly.

In Canadian National Railway v. Inglis Ltd.,35

the Ontario Court of Appeal

considered a clause which provided that rent on renewal was to be set at “an amount which in the

opinion of the lessor is fair and equitable.” The landlord fixed the annual rent using a formula

designed to produce a 12% return on the value of the lease property appraised on the basis of its

unrestricted highest and best use plus seven% escalation factor. The trial judge determined that the

rental value of the property was to be based upon the fair and reasonable value of each of the leased

parcels for the manufacturing purposes of the lessee, and not on their unrestricted highest and best

use. The landlord appealed to the Ontario Court of Appeal, and the appeal was dismissed. The

Court held that as the lease was worded, the determination of what rent was fair and reasonable was

to be based upon what was fair and reasonable as between the parties to the lease in the context of

circumstances of the use of the land, rather than in the abstract. The Court went on to say that the

method used by the landlord to determine the rent, the hypothetical highest and best use of the land,

was significantly divergent from the actual use of the land by the lessee.

The Ontario Court of Appeal held that the clause required the lessor to meet an

objective standard of reasonableness. It did not empower the lessor to fix rent on a subjective basis

at whatever rate it may have believed appropriate, but rather it compelled it to determine reasonably

what it thought to be fair and equitable as between the parties in the context of their relationship and

in light of all of the relevant circumstances. Further, the lease restricted the lessee’s use of the

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property to manufacturing and, therefore, the formulation of a fair and equitable rent must be

determined by reference to the stipulated use in the lease rather than a valuation devoted to highest

and best use.

9. MEDIATION

Essentially, mediation is assisted negotiation: “A mediator’s role is to assist the

parties to reach an agreement.”36

Mediation can be a useful process in situations where both parties

are unable to agree, but genuinely wish to reach an agreement. Richard Olson, in his text, A

Commercial Tenancy Handbook, supra, sets out some of the advantages of mediation:

1. Mediation is time efficient;

2. Mediation allows an agreement to include terms that could not be imposed by an arbitrator

(i.e. additional renewal term, additional tenant’s inducements, a change in the premises, etc.);

and

3. Mediation is not adversarial, and as such there it generally limits the damage to the ongoing

relationship between the parties.37

Despite its many advantages, mediation also has its disadvantages, including:

1. In mediation, the mediator may not make a binding ruling on the rent for the renewal term;

and

2. if no agreement is reached, the parties will be obliged to litigate or follow any other

35

Canadian National Railway v. Inglis Ltd., 153 D.L.R. (4th) 291, 36 O.R. (3d) 410 (Ont. C.A.) [“Canadian National”]. 36

Supra note 2 at 5-5. 37

Ibid.

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procedure set out in the lease.38

10. OTHER PROCESSES

A landlord and a tenant may jointly agree to use any other process they can invent

to determine the rent for a renewal term.

Courts are becoming increasingly sensitive to the needs of Landlords and Tenants

to resolve their disputes in efficient and inexpensive ways. In Manitoba, once a Statement of

Claim has been filed, parties can benefit from various resolution mechanisms including:

mediation, early non-binding opinions, and mediations followed by a binding hearing.

For example, in the case of a dispute, the lease may require each party appoint an

experienced commercial appraiser and that if their appraisals are within 10% of each other, the

Fair Market Land Value will be the average of the two. If the appraisal differential exceeds 10%,

the two appraisers are to appoint a third, whose determination of Fair Market Land Value shall be

final.39

In Concord Pacific Developments Ltd. v. British Columbia Pavilion Corp.,40

two

Crown Corporations decided that the rent for a particular property would be determined by a

variation on the “baseball arbitration”. The interest of one of the Crown Corporations was acquired

by a private developer. The parties jointly hired an appraiser who was instructed to determine the

38

Ibid. 39

Centre for Addiction and Mental Health v. 2041134 Ontario Ltd., 2006 CanLII 6081 (ON SC) 40

Concord Pacific Developments Ltd. v. British Columbia Pavilion Corp. (1991), 60 B.C.L.R. (2d) 121, 1991

CarswellBC 245.

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fair market rent for the premises. Once he had completed his appraisal, he was to notify the parties

that he had done so, and the landlord and the tenant were to send him a letter setting out the rent

which each of them proposed. The arbitrator then was to select the closest rent to the appraiser’s

figure. This process was held to be an arbitration.

CONCLUSION

Enforceable lease renewal provisions should contain some definite language that

clearly sets out the procedure for the tenant to exercise the renewal provision. This language should

include, for example, a time period for exercising the option to renew, the form of notice from the

lessee to the lessor regarding the lessee’s intent to exercise the option, and the means of executing

the option. Appraisers can add value to leasing negotiations as they can provide useful insight on the

formula proposed for the renewal or extension of a lease. This advice can enhance certainty in

business relationships and reduce unnecessary litigation expenses.

APPENDIX A

WHAT TO LOOK FOR IN A RENT RENEWAL PROVISION

FORMULA FOR RENT

Is the market value test modified in any way?

Is there an effective date?

Is the use the tenant’s use, or are there restrictions on use, of the premises?

Are the comparisons limited by location, use, age, size or some other factor?

What does the renewal provision mean, on a plain reading of the words?

Is the lease being renewed or extended? If the lease is renewed are there any provisions

which cease to be binding such as a first right of refusal on other space or a first right to

purchase the property? How this impact the market rent?

BUILDINGS AND IMPROVEMENTS

Is the subjective approach or the objective approach called for in the agreement?

Does the agreement stipulate that the buildings and/or improvements will or will not be

factored into the rent renewal determinations?

Is the "as was" or the "as is" condition being applied?

ARBITRATION

Do the parties wish to have a right of appeal?

Is a right of appeal provided for in the agreement?

Is the decision of the arbitrator binding?

FAIR AND EQUITABLE IN THE OPINION OF THE LESSOR

What is fair and reasonable as between the parties, not as the hypothetical highest and

best use?

What is the actual use of the land?

Is the objective standard of reasonableness being applied?

Have all of the circumstances and facts of a given case been considered?

MEDIATION

Is time of the essence?

Do the parties genuinely wish to seek an agreement?

Do the parties wish to avoid an adversarial process?

Do the parties wish to keep the cost down?

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OTHER PROCESS

Judicially Assisted Dispute Resolution - consider whether to use this process instead of

Arbitration.

Baseball Arbitration?