The Court of Appeal’s decision in 2177 23rd Avenue Holdings v. Pival International Inc. , dated January 9, 2025, has already sparked significant discussion regarding the rules applicable to the exercise of a renewal option in a commercial lease and the obligation to negotiate in good faith in the context of exercising such an option.
This decision drew considerable attention because the clause at issue in the commercial lease is one frequently found in leases across Quebec. The Court of Appeal ruled that the tenant did not have a true renewal option in their commercial lease.
Under the lease in question, once the tenant had given notice to exercise its renewal option, the parties were required to agree on the rent to be paid, failing which the option would become null and void. The final rent was to be determined based on a specific criteria, essentially a comparative market analysis for a similar term in a comparable building in the same area. However, the core issue was what happens if the parties cannot agree on the rent? Is it fatal to the tenant? The renewal option in the lease was ultimately deemed unenforceable because it did not provide that, in the absence of an agreement on rent, the rent would be determined by mandatory arbitration or through a formula that would conclusively fix it. Because these essential components were missing, the Court of Appeal held that the lease did not contain a real enforceable renewal option in favour of the tenant. As a result, the tenant could not request the enforcement of that option.
The Court also held that if one party acts in bad faith during the rent negotiation period, this does not give the court the authority to set the rent on their behalf. In such a case, a party acting in bad faith may be liable for damages if a prejudice was caused, but the mere presence of a clause requiring the parties to agree on a new rent according to certain criteria does not create a contractual obligation to reach an agreement. The Court of Appeal concluded that: “the obligation to perform clause 27.6 of the lease in good faith did not oblige the parties to contract, nor did it dictate the outcome of the negotiations (translation).” The Court went further, expressing doubt about the effectiveness of specific performance to enforce an obligation to negotiate in good faith, and considered that awarding damages to the party having suffered prejudice was the more appropriate remedy.
Given that this type of clause is very common in the real estate industry, until commercial leases are revised at the request of experienced tenants to include all essential elements of a true renewal option, landlords may be tempted to exert significant pressure on tenants during rent negotiations after the tenant expresses a desire to remain in the leased premises, often after making substantial investments in such premises.
For now, as the market currently favours tenants, landlords are likely to welcome a tenant who wishes to renew their commercial lease and will probably not apply undue pressure, knowing the tenant might simply relocate. However, market conditions vary across regions and asset classes, so commercial tenants must exercise extreme caution and carefully review any renewal option clause in their commercial leases.
What about the impact of this decision on commercial contracts other than leases? To our knowledge, no legal expert has yet addressed this important question.
In fact, many contracts that aim to establish long-term business relationships include an option or a preferential right to be exercised in the future by one of the parties. This is often the case, for example, in a purchase offer or an option to purchase where the parties have agreed on a purchase price for a property and the purchaser is granted the right to purchase additional lots in future development phases. Often, the purchase price for those additional lots is not definitively established. As in the lease clause examined by the Court of Appeal, if the parties fail to agree on the option price and there is no mandatory mechanism to definitively fix it, or if it is stipulated that the option is rendered null in case of disagreement, the purchase option is likely to suffer the same fate as the one in Pival International.
The same consequences are likely in other business contexts.
Take, for example, a franchise agreement, which often includes a renewal option. A franchisee who has invested significant money over the years could see its right to renew extinguished if the renewal clause is poorly drafted.
Similarly, an emphyteutic lessee who has invested heavily in improvements or construction and has a renewal option for the emphyteutic lease term could be forced to relinquish its improvements earlier than expected if the option clause does not contain the required ingredients to make it enforceable.
As a final example, consider a startup looking to sell or license a developing technology. At an early stage, the company may turn to investors or lenders for additional capital. In an agreement to invest substantial capital in exchange for the right to purchase the technology once it is mature, the parties might agree to an option to purchase based on certain parameters, but without a definitive pricing mechanism. What happens if this investor, having injected significant capital and relying on the promised option, finds itself unable to enforce it due to the lack of a definitive price, especially when the developer now seeks to sell the technology to the highest bidder?
The old adage “the devil is in the details” has never rung more true than when it comes to an option in a commercial contract, particularly when that option carries significant business value.
By : Nicolas Beaulieu, attorney and partner at Gascon & Associates L.L.P.