Residential and Commercial Tenancies Due Diligence

5th Annual Real Estate for Law Clerks – October 17, 2006

Jim Weber, McMillan Binch Mendelsohn LLP

Introduction

The extent of due diligence to be performed by a law clerk on a leasing transaction, whether commercial or residential, always depends on the specific characteristics of the transaction. The due diligence to be performed for a client who is leasing 1,000 square feet of office space in a large downtown office tower will be considerably different than that done for a client who is entering into a 20-year lease for a design-build industrial facility. In a sale-leaseback scenario, there may be no due diligence required by the vendor/tenant at all. Also, it is a different type of due diligence that will be performed when acting for a client who is purchasing a property in a transaction where leases will be assigned by a vendor and assumed by a purchaser.

The starting point in any leasing transaction where the law clerk is assisting in conducting due diligence is to understand the details of the transaction. This includes a determination of the following:

• Is your client entering into a lease? If so, as landlord or tenant?

• Is the transaction one in which your client will be assuming obligations under a lease?

• What type of property is subject to the lease: residential, office, retail, industrial, recreational or other?

• What is the term of the lease, and are there any renewals?

• Are there any unique aspects of the property that require special investigation?

Understanding the transaction is only part of the exercise; the other part is understanding your client. It is important to discuss with your client, at the outset of the transaction, their potential liability as a tenant of a property or as a landlord under an assumed lease. You need to discuss the level of risk that your client is willing to assume, and the extent to which risk can be limited through due diligence, insurance, title insurance and contractually under the Lease.

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It is an important and complex task to complete appropriate due diligence on a leasing transaction. This paper is intended to provide some assistance by reviewing the following areas of leasing due diligence: (1) tenant estoppel certificates, (2) commercial leasing, and (3)

residential leasing. While these topics only “scratch the surface” of what may be required on a transaction, hopefully they will provide a starting point of reference for your due diligence on leasing transactions.

Tenant Estoppel Certificates

• A tenant estoppel certificate is a certificate executed by a tenant addressed to specific addressees (usually a lender, a landlord or a potential purchaser) certifying the status of that tenant’s tenancy and the terms of its Lease.

• A tenant estoppel certificate may also be called a status statement or tenant acknowledgment.

• Estoppel certificates are commonly required in sale and financing transactions involving properties subject to leases.

• The purpose of tenant estoppel certificates is to allow the addressee to obtain verification of the status of the tenancy and the Lease directly from the tenant, and to estop the tenant from subsequently claiming that the tenancy or Lease terms are other than as set out in the estoppel certificate.

• The requirement for a tenant to provide an estoppel certificate is based on its contractual obligation under the Lease, and this obligation is found in virtually all commercial leases. A typical lease provision dealing with estoppel certificates is as follows:

The Tenant shall at any time and from time to time execute and deliver to the Landlord or as the Landlord may direct, within five business days after it is requested, a statement in writing, in the form supplied by the Landlord, certifying that this Lease is unmodified and in full force and effect (or if modified, stating the modification and stating that the Lease is in full force and effect as modified), the Commencement Date, the amount of the Minimum Rent and other Rent then being paid hereunder, the dates to which such Rent hereunder has been paid, whether or not there is any existing default on the part of the Landlord of which the Tenant is aware and any other particulars that the party requesting such statement may reasonably request.

• The following issues are generally addressed in all estoppel certificates:

1. the date of the Lease and any amendments thereto;

2. a statement that the Lease is in full force and effect;

3. confirmation of the term and any renewals;

4. the rent payable by the tenant under the Lease;

5. the amount of security or rent deposits held by the landlord; and

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6. confirmation that each of the parties is in good standing under the Lease, or details of any defaults or outstanding disputes between the parties.

• In addition to outlining specific matters that need to be addressed in the estoppel certificate, most Leases will add generic language that allows the landlord to add to the estoppel certificate other factual matters on which it requires certification. This generic language is required to ensure that landlords can include statements that may be prescribed by particular lenders. When acting for a tenant, it is appropriate for you to resist (on behalf of your client) certifying as to matters that can be determined independently by the addressee (i.e. status of taxes, zoning, title matters, etc.). A good way to ensure that the content of the estoppel certificate is appropriate is to negotiate the estoppel certificate during the Lease negotiations and attach it to the Lease as a schedule.

• Occasionally you will see a form of estoppel certificate which contemplates attaching the entire Lease as a schedule; in addition to building a mountain of paper, this is (in the writer’s view) unnecessary and defeats the purpose of obtaining the estoppel certificate.

• Tenants will need to modify certain statements in the estoppel certificate to be to “the best of its knowledge” depending on the content of the statement. For example, the statement that the landlord is not in default under the Lease may need to be “to the best of the tenant’s knowledge”.

• Certain lenders have their own form of estoppel certificate that they require from tenants; when acting for a landlord, try to ensure that your Lease provisions relating to the estoppel certificate are flexible enough to require the tenant to provide an estoppel certificate on the lender’s form.

• Ideally from a landlord’s perspective, the Lease under which an estoppel certificate is being provided will have a timeline within which the tenant must provide the executed estoppel certificate. In some cases there is no timeline and frequently tenants do not abide by these timelines; the request for an estoppel certificate by a landlord is generally a low priority item for a tenant. Accordingly, as the clerk responsible for obtaining the executed estoppel certificates on behalf of your landlord client, you should ensure that the request and form of estoppel certificate is sent to the tenant as early as possible. The request for the estoppel certificate should be sent in accordance with the notice provisions of the Lease.

• When acting for a tenant providing an estoppel certificate, consider adding the following provision to the estoppel certificate: Notwithstanding any provision hereof, this estoppel certificate is given solely for the benefit of , and may not be relied on or used by any other party. Regardless of any inaccuracy or misstatement herein, this estoppel certificate shall create no liability on the part of the tenant to any other person or entity and, as between the landlord and the tenant, does not amend the Lease.

• Attached to this paper as Exhibit “A” is a comprehensive form of tenant estoppel certificate.

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• The following cases were located by the writer which deal with various issues pertaining to estoppel certificates:

358426 Ontario Ltd. v. Liappas – Ontario Court of Justice (General Division) [1994] O.J. No. 2371 (solicitor’s negligence case relating to waiver by purchaser of requirement to obtain estoppel certificates on closing)

Confed Trust Co. v. Gasland Oil Ltd.- Alberta Court of Queen’s Bench [1993] A.J. No. 437 (tenant estopped from raising a claim that was inconsistent with information provided in estoppel certificate relied upon by the plaintiff)

473807 Ontario Ltd. v. TDL Group Ltd. – Ontario Court of Appeal [2006] O.J. No. 3050 (see para. 57)

Georgian Group Inc. v. Oakville Gem Construction Ltd. – Ontario Superior Court of Justice [2000] O.J. No. 1581

Commercial Leasing

• A “commercial lease” is a broad concept that applies to leases for a variety of different properties.

• This part of the paper will outline some of the basic due diligence searches that should be considered when acting for a tenant entering into a commercial lease.

• As commercial tenants often lease the property, building or premises on an “as is” basis, it is imperative that tenants complete appropriate due diligence, as they will have no recourse to the landlord (except in limited circumstances) if there are deficiencies that could have been disclosed by their own due diligence.

• In addition to the searches listed below, in certain circumstances you should advise your tenant client to retain a building inspector or engineer to complete a comprehensive building inspection and to retain a qualified environmental consultant to complete an environmental site assessment.

• When acting for a landlord, consideration should be given to obtaining a credit check, bank references or other financial information, such as financial statements, to satisfy the landlord that the tenant has the ability to meet its financial obligations under the Lease.

• Status of Landlord/Tenant:

o Like any commercial contract, it is necessary to ensure that the party you are contracting with is an entity that is subsisting and has not been dissolved, and has legal capacity to enter into the contract.

o Obtain a Certificate of Status (Ontario corporation) / Certificate of Compliance (federal corporation), which verifies the date of incorporation

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and certifies that the corporation is subsisting as of the date of the certificate.

o It is imperative to a landlord that it verifies who the tenant is; is it a “shell” company? If so, consideration should be given to obtaining an appropriate indemnity or other security (i.e. security deposit, letter of credit, etc.). The landlord needs to ensure the tenant has a financial covenant to satisfy its obligations under the Lease.

• Zoning/Building Compliance:

o The extent of your zoning investigation will depend on the specific transaction.

o Some tenants entering into office leases in office buildings elect not to complete any zoning enquiry at all.

o Zoning is important because the by-laws impact on use, parking, signage, tenant’s work and other development or alterations of the property upon which the premises is situate. You need to review the “use” provisions in the Lease carefully to determine if the tenant is obligated to satisfy itself that its intended use is permitted. In some circumstances, a tenant may be able to obtain a representation and warranty from the landlord that the applicable zoning by-law will permit the tenant’s use.

o Notwithstanding that the incoming tenant will not be responsible for outstanding work orders, it is an indicator of the condition of the building and the landlord’s overall maintenance standards for the building.

• Subsearch/Title Search:

o A subsearch of title is completed to verify that the entity entering into the Lease, as landlord, owns the property or otherwise has authority on behalf of the owner to rent the property to the tenant.

o Leases generally contain a legal description of the property upon which the building/premises are situate; it is necessary to ensure that this legal description is accurate to confirm that the correct property is described in the Lease and so that a proper description is available for preparation of any notice of lease that the tenant may wish to register.

o Depending on the transaction, a tenant may wish to complete a full search of title. This is particularly important for a land lease where the tenant is constructing its own building.

o A tenant needs complete a subsearch to determine if there any mortgagees on title from whom it may require a non-disturbance agreement. A non-disturbance agreement is an agreement between a mortgagee and the

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tenant under which the mortgagee agrees that in the event it forecloses on its mortgage, takes possession of the property or exercises its power of sale, the tenant will be permitted to remain in the property under the terms of the Lease, provided it is not in default under the Lease.

o The tenant will need to verify if there are any agreements, covenants or restrictions registered on title which will impact on its intended use of the premises.

o Depending on the types of tenancy, access may be of critical importance; reviewing title to verify access will be required.

• Environmental Investigations:

o Most commercial leases have comprehensive environmental provisions that impose significant environmental compliance requirements on tenants, particularly in leases of industrial premises.

o The extent of environmental due diligence required depends on the type of property being leased, the activities of previous tenants and the intended use of the premises.

o Given that a tenant is assuming responsibility to comply with environmental laws during its tenancy and to remove any environmental contamination caused during its tenancy, the tenant needs to be able to verify the environmental condition of the property at the time it leases the property.

o Consideration should be given to hiring a qualified environmental consultant to complete an environmental site assessment.

o A records search can be completed with the Ministry of Environment.

o A search can be completed under the Environmental Site Registry to determine if a Record of Site Condition has been filed in connection with the property.

• Other Searches to be considered:

o Ontario Heritage Act - may impact on the alterations or modifications that can be made to the property.

o Unregistered easements.

o Fire Department records search.

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o Electrical Safety Authority.

o Conservation Authority.

o TSSA – elevating devices / underground storage tanks / boilers and pressure vessels.

Residential Leasing

• In Ontario, residential tenancies are currently governed by the provisions of the Tenant Protection Act, 1997 (Ontario); however, this Act is to be repealed and be replaced by the Residential Tenancies Act, 2006 (Ontario), which has received Royal Assent but has not yet come into force. This new Act is supposed to come into force in early 2007.

• In addition to the due diligence issues that need to be addressed for a commercial lease, when a client is purchasing a residential rental property, the lawyer will be obligated to complete a rent review as part of its due diligence (unless it has specifically limited the retainer to exclude this review).

• The residential rent legislation in Ontario is complex and in many cases an initial determination has to be made as to whether the law firm will even undertake the rent review, or whether this work should be contracted out to an independent rent control consultant. Dealing with the various historical rent-related legislation is a daunting task. Rent was previously legislated under the Residential Rent Regulation Act, the Rent Control Act, 1992 (repealed June 17, 1998) and now the Tenant Protection Act, 1997, and soon the Residential Tenancies Act, 2006.

• See Bill 109 attached as Exhibit “B” which provides a summary of the proposed amendments to Ontario’s residential tenancy legislation under the Residential Tenancies Act, 2006.

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EXHIBIT “A”

TENANT ESTOPPEL CERTIFICATE

TO: and its successors and permitted assigns (“Purchaser”) and lender(s) and their successors and assigns (“Lender”)

AND TO:

RE: Lease dated , 200 between , as Landlord, and the undersigned, as Tenant, as amended or renewed (collectively, the “Lease”), a true copy of which is attached hereto as Appendix B.

RE: (the “Property”)

The Tenant certifies the following items and is estopped from denying the following:

The undersigned (the “Tenant”) is a tenant of space (the “Leased Premises”) in the Property under the Lease, details of which are shown on Appendix “A” hereto.

Except as set out in Appendix “A”:

the Lease has been validly executed and delivered by the parties thereto and we have taken possession of and are open for business in our space and have commenced paying regular instalments of monthly rent;

the Lease is unmodified and represents the entire agreement between the Landlord and Tenant and there has been no commutation or termination of the Lease or any release, variation or increase of the obligations of the Landlord or the Tenant;

the Lease has not been assigned nor has any part of the space been sublet by the Tenant;

the Leased Premises have been fully completed and built out in accordance with the obligations of the Landlord pursuant to the Lease and the Leased Premises is free from any construction deficiencies.

the Landlord has agreed to supply to the Tenant, or to employees of the Tenant, the following parking in the Property at the following rates: .

rent and all other amounts due under the Lease have been paid to today’s date, there has been no prepayment of rent or any other amount payable under the Lease, other than payment of the current month’s installment of rent, and no security deposit has been paid under the Lease;

there are no loans outstanding between the Tenant and the Landlord, whether for Tenant improvements or any other purpose and there are no amounts owing to the Tenant by the Landlord;

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there is no default of the Tenant under the Lease or, to the Tenant’s knowledge, on the part of the Landlord, and all work or other obligations required to be performed by the Landlord and Tenant have been so performed and the Lease is in full force and effect;

there is no existing defense, counterclaim, set off, dispute or claim under or in respect of the Lease by or against the Landlord and there is no reason why the obligations of the Tenant under the Lease may not be fully enforced in accordance with their terms; and

there are no amounts due or to become due by the Landlord in connection with the Lease in respect of inducements, rent-free periods, lease pick-up obligations, tenant allowances or similar items.

The Tenant acknowledges that a sale of the Property is pending to the Purchaser and the Purchaser and Lender, amongst other things, are relying on the contents of this Estoppel Certificate. The undersigned agrees that upon receipt of notice from the Landlord of the completion of the sale of the Property, it shall attorn to and become the Tenant of the Purchaser and make payments of rent and other monies payable under the Lease from and after the closing of the transaction to the Purchaser or as it shall direct. The Tenant will, where applicable as a result of the Lender exercising its rights pursuant to any security held by the Lender, upon notice from the Lender, attorn to the Lender and recognize the Lender as landlord under the Lease for the remainder of the term thereof in which event Tenant shall perform and observe its obligations thereunder for the remainder of the term thereof, subject only to the terms and conditions of the Lease. The foregoing is acknowledged by the Tenant on the understanding that, so long as the Tenant is not in default under the Lease, the Tenant’s interest under the Lease shall not be disturbed by the Lender.

There is no option to purchase or right of first refusal in favour of the Tenant with respect to the Property or any part thereof.

DATED this day of 200 .

[TENANT NAME]

Per: Name: Title: I have the Authority to bind the Corporation

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APPENDIX “A”

LANDLORD:

Tenant:

Date of Commencement:

Amendments to Lease:

Assignment of Lease:

Sublet of Tenant:

Expiry of Term:

Renewals:

Rentable Area:

Base Rent:

Percentage Rent:

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Prepaid Rent:

Security Deposit:

Additional Rent:

Unit No.:

Buildings Address:

Special Provisions:

Tenant Allowances:

Parking Fees:

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EXHIBIT “B”

SUMMARY OF BILL 109

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