The Duty of Good Faith, or: How Not to Let Courts Rewrite Your Lease

In November 2014, the Supreme Court of Canada released its decision in Bhasin v. Hrynew, holding that in Canadian law every party to a contract has a duty to perform that contract in good faith.

Much ink—and some tears—has been spilt over what the duty of good faith in contractual performance means in various business contexts. Bhasin and recent cases interpreting it establish that landlords, both commercial and residential, must be very careful in negotiating, performing and terminating leases, lest the courts impose drastic remedies that, in a pre-Bhasin world, would be unheard of.

The concept of a lease is very old. The law relating to them, at least in the British Commonwealth, goes back to feudal England, when rich landowners owned almost all the land fee simple, and peas­ant farmers purchased rights to the land through leases. Because of this long legal history, leasing can involve embedded legal principles that trip up landlords and tenants when they are not careful.

In the modern B.C. context, most leases are governed by legislation, usually the Commercial Tenancy Act or the Residential Tenancy Act. While the legislation has added a degree of clarity to the relationship between landlords and tenants, there are still unwritten legal rights and obligations that can arise in certain circumstances. Further, some leases in British Columbia are not governed by any specific legislation, including 99-year residential leases like those in Vancouver’s False Creek area.

In the past, B.C. courts have interpreted leases, particularly commercial leases, to be arm’s-length contracts that do not contain any additional duties of good faith. However, this is no longer the case post-Bhasin.

In a recent decision from Ontario, Osteria Da Luca Inc. v. 1850546 Ontario Inc., the Court applied the Bhasin duty of good faith in a commercial leasing context to grant a three-month lease extension, despite the fact that the landlord and tenant had not agreed to the extension, and that the land­lord had already entered into a new lease with a new tenant and the term of the new lease started during the court-imposed lease extension.

In Osteria, a restaurant tenant called Osteria Da Luca held a commercial lease, with no right to renew. Osteria contacted the landlord several months before the lease expired to negotiate a new lease. The parties discussed a new lease over the course of several months, including meeting to discuss the terms.

The tenant alleged in court that, at the meeting, the landlord’s property manager promised he would have a lawyer prepare and forward a new lease. The landlord disagreed with this version of the facts; the property manager’s evidence was that, although new terms had been discussed and the parties were close to agreement, he had not promised to enter into a new lease, and he had stated that further approval from the landlord was required.

A month before the lease expired, Osteria learned that the landlord had agreed to rent the premises to a new tenant, and contacted the landlord to confirm it under­stood that the two of them had already agreed to a new lease. The landlord did not reply except to tell Osteria Da Luca “not to get excited”.

The landlord then gave Osteria notice to vacate eight days before the existing lease ended. The tenant immediately sought an emergency court hearing, and was granted short-term lease extensions until it could have its application for a longer term lease extension heard.

Eventually, the Court granted Osteria Da Luca an injunctive three-month lease extension because the landlord had breached its obligation of negotiating in good faith. It found the landlord knew or ought to have known that the tenant understood a new lease had been negoti­ated and agreed to, and had relied on that understanding. The judge also found that the landlord should have told the tenant that it was entertaining other offers and that the landlord did not consider itself committed to entering into a lease. The judge also relied on the fact that Osteria Da Luca had spent $120,000 on improvements during its tenancy.

The lease extension was granted despite the fact that the parties had no written contract for an extra three-month term, and that the landlord had entered into a new lease with a new tenant, beginning immediately. No consideration was given to the landlord’s obligations to the new tenant, who could not move in during the lease extension granted by the Court.

Further, the Court seemed to ignore that in the normal course, Osteria Da Luca would not have been able to keep the benefit of the $120,000 in tenant improvements at the end of the lease in any event. Remember, the lease contained no option to renew.

An injunctive lease extension without a written contract is an extremely unusual remedy. Courts are generally loath to write contracts for parties. The Court could have found that the landlord owed the tenant damages as the result of its bad faith negotiations, which would have interfered less in the rights of the landlord to negoti­ate its own contracts. However, it was inclined to allow the restaurant tenant to wrap up its business in an orderly fashion at its current premises rather than resort to a judgment for damages.

What are the lessons for landlords arising from Osteria and Bhasin? For one thing, don’t tell a tenant “not to get excited” while you plan to deliver a surprise notice to vacate. That kind of conduct can cer­tainly annoy judges.

Landlords should also be aware that they have a broad duty of good faith, and that its obligations can exceed the written terms of any given lease. Good practices for landlords vary in every circumstance, but can include putting all communica­tions in writing, including recording minutes at meetings with tenants or potential tenants, and providing all relevant information to a tenant during negotiations, including disclosing if you are entertaining other offers.

Having a clear lease—or no lease at all—is no longer enough to ensure certainty between tenants and landlords.

For more information on negotiating leases and managing lease disputes please contact Claire.

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