Quebec Appeal Court seeks to avoid opening floodgates for claims against landlords, say experts

In an “important” decision that examines and delineates the scope of legal disturbances, the Appeal Court held that government public health orders imposed during the pandemic do not constitute a legal disturbance as defined under article 1858 of the Civil Code of Quebec (CCQ) because it does not apply to immovables, noted legal pundits.

The ruling also sends a strong message that that appellate courts will review penalty clauses embedded in all contracts, and not just contracts of adhesion, to ensure that they are contractually fair and that they take into account exceptional circumstances, they added.

“You could fairly say that what the court is worried about is the floodgates argument, that if they were to allow (article) 1858 to be interpreted in a way that goes beyond what previous case law had allowed then you’re kind of into a new area where the limits of (article) 1858 are no longer certain,” remarked Christopher Richter, a trial and appellate lawyer who practises civil, corporate and commercial litigation with Torys LLP in Montreal. “You could see where if this kind of exception were included within the ambit of (article) 1858, then other tenants would be trying to apply other exceptions as well. They wanted to avoid that.”

MTY Franchising Inc., a subsidiary of  MTY Food Group Inc. (TSX: MTY), one of the largest franchisors and operators of multiple restaurant concepts worldwide that generated $4.3 billion in fiscal 2022, ceased operating a café in downtown Montreal in March 2020, a couple of weeks after a state of health emergency was declared by Quebec to deal with the pandemic. A week after the Quebec government issued a decree in March 25th that allowed restaurants only to service car-orders and takeout’s and make deliveries, MTY sent a letter to its lessor stating that it was having difficulty maintaining operations and was seeking to reach a rent reduction agreement. MTY pointed out that it did not qualify for the federal government’s commercial rent assistance program for small businesses, which provided for a federal government subsidy of 50 per cent of the rent and in exchange the landlord must reduce the rent by 25 per cent, which represents a 75 per cent reduction for the tenant. MTY asked the lessor to grant it the same 75 per cent reduction, which it refused. It then subsequently stopped paying the rent, without leaving the premises or returning the keys. The case went before the courts.

In May 2022, Quebec Superior Court Justice Silvana Conte allowed the lessor’s action for rent, taxes and contractual penalties and ordered MTY jointly and severally to pay more than $220,000 with interest at 5.45 per cent per annum from January 31, 2022.

Before the Quebec Appeal Court, MTY argued that the orders in council and ministerial decrees constitute a legal disturbance within the meaning of article 1858 of the CCQ because it deprived them of the enjoyment of the premises, that is, the operation of a café with a dining room. They further argued that the notion of legal disturbances, which is not defined in the CCQ, stems from the 1973 reform of the lease provisions of the Civil Code of Lower Canada, the purpose of which was to strengthen the protection afforded tenants. It should therefore be given a broad interpretation and refer to an obligation to guarantee against any purely legal obstacle to the enjoyment of the leased property, they added. Case law and doctrine recognize that a zoning by-law constitutes a disturbance of the law, and the same must apply to any normative act that has an effect on the activities that may constitute the use of a place, asserted the franchising giant. Though the purpose of health decrees is different from zoning in that they relate to public health, MTY maintained that their object is the same – the exercise of a power that has the effect of limiting the use of an immovable. The orders in council would therefore apply to the immovable as much as to the zoning by-law, and would be no less a disturbance resulting from the exercise of a right by a third party than the zoning by-law.

That’s why MTY refused to pay their rent, under the exception of non-performance, which is a means of suspending performance of the obligation of the party invoking it until the other party has performed. MTY was seeking a reduction of their obligation under article 1863 C.C.Q. because of the alleged legal disturbance.

In a unanimous decision in Franchise MTY inc. c. Lechter (Édifice professionnel de Montréal), 2023 QCCA 1284, the Appeal Court rejected MTY’s “appealing” argument on “the face of it” because it “does not stand up to analysis.” Article 1858 imposes on the lessor an obligation to warrant the lessee against legal disturbances to the enjoyment of the leased property, which is intended primarily to protect the lessee against eviction by a third party who asserts a right over the leased property. The concept of a legal disturbance has been broadened by case law and doctrine to include acts of public authority that have the effect of prohibiting the use of premises for certain purposes, such as zoning bylaws, pointed out Appeal Court Justice Benoît Moore in reasons concurred by Justices Mark Schrager and Lori Renée Weitzman.

But the nature of the restrictions arising from health decrees is different from those of zoning by-laws, noted Justice Moore. The effects of the norm, which in both cases are a control on the use that can be made of a place, must not be confused with the object of the norm, he cautioned. Health decrees aim to restrict certain activities and gatherings of the population in order to protect public health not the management of buildings in a given area. “If they have any effect on buildings, it is only incidental,” noted Justice Moore. Zoning bylaws, on the other hand, affect directly and exclusively to immovables, placing a permanent and direct restriction on their use.

“The extension of legal disorders to health decrees would, in my view, constitute a break with the very nature of that concept,” added Justice Moore. Health decrees do “not constitute a purely legal” disturbance but represent the “consequences of a purely factual situation,” said Justice Moore. “Admittedly, this is not a de facto disturbance either, but the nature of the event, its one-time nature and the fact that it occurred after the contract was entered into combine to move away from the purpose of article 1858 C.C.Q. and transform it into a provision that places a wide range of contractual risks on the lessor’s shoulders,” held the Appeal Court. “The consequences of such an opening would be difficult to foresee.”

The Appeal Court “quite rightly” wants to avoid opening the “floodgates” for claims against landlords under Article 1858, said Andrei Pascu, a Montreal litigation lawyer specializing in commercial real estate and product liability at McMillan LLP. “What I find interesting about the Appeal Court’s decision is that it also looks at the impact of a potential decision on lessors,” said Pascu. “If the Appeal Court decided that Article 1858 applied, and that indeed there had been a legal disturbance, then the lessor could perhaps even be sued for failing to provide enjoyment of the right to operate, and therefore the right to use the premises for the purposes set out in the lease.” Landlords would then become guarantors of the ability of each tenant to carry on its activities, and could be held liable for reasons beyond their control such as health decrees, added Pascu.

The decision represents a continuation of the court’s fairly conservative view on where the risk lies as a result of the COVID-19 shutdown, said Richter. “If there is a problem with zoning requirements, you cannot as a tenant insist on your rights under the lease, because that would run counter to the zoning. But it is an obligation of guarantee by the landlord, and therefore you do have recourses,” explained Richter. “In this case, they found, of course, that it was not a legal disturbance because it’s a general regulation affecting commerce as a whole, rather than affecting the premises as such. It’s an important decision, and interesting from a legal point of view.”

The Appeal Court held that situations such as the case at bar appear to be instead governed by the notion of “force majeure” and the general obligation of enjoyment of the premises set out under article 1854, paragraph. 1 of the CCQ – an argument that surprisingly was not mounted by the appellants, said legal pundits. “Although this issue is not part of the legal debate, it remains unresolved,” said Justice Moore. But in July 2020, then Quebec Superior Court Justice Peter Kalichman, now with the Quebec Appeal Court, held that a commercial landlord was not entitled to collect rent from its tenant because a Quebec government decree that suspended non-essential business activities for three months to stem the flow of the pandemic constitutes “force majeure.”

The Appeal Court decision however partly overturned the lower court ruling over the penalty clauses found in the lease. The appellate court found that the trial judge committed a palpable and overriding error in concluding that the penalty equal to 44 per cent of the base rent, in addition to an interest rate of 5.45 per cent, was not abusive.

The Appeal Court underlined that regardless of whether or not the penalty is intrinsically abusive, it has reiterated several times that the abusive nature of a penalty clause may also be circumstantial. “In the case at bar, the judge completely disregarded the circumstances, which, it will be agreed, were particularly exceptional, including the health crisis, the resulting operating loss, the absence of government assistance, the decline in occupancy of the building and the fact that the respondent had granted a 25 per cent reduction to tenants benefiting from the government program,” said Justice Moore. The penalties were reduced to a total rate of 15 per cent.

That is a finding that Pascu expects will be cited in the future when the courts are assessing penalty clauses. “It is interesting to see the Appeal Court consider the pandemic as a mitigating circumstance or an important circumstance to be taken into account in its assessment of what is a reasonable penalty in this contract,” said Pascu.

Richter too found it “interesting” that the Appeal Court reduced the amount of the penalty after conducting an equitable analysis. “What’s interesting from a landlord-tenant and COVID crisis perspective is that they underline that the landlord did not give the 25 per cent discount that everybody else was getting on their lease,” said Richter. “It is unlikely to really change the law regarding penalty clauses, but it is a strong indication to landlords that they should be trying to do something for their tenants.”