The struggle between landlords and tenants
regarding capital costs is not a new one.
Commercial leases address this issue in a variety of ways. A very recent decision of the Ontario
Superior Court of Justice in RioCan Holdings
Inc. v. Metro Ontario Real Estate Limited
 ONSC 1819 provides an in-depth analysis of language in a retail shopping centre lease
that excluded from additional rent charges “expenditures which by accepted
accounting practice are of a capital nature . . .”
The facts of the case are
straightforward. In 2002, RioCan (the
landlord) rehabilitated the parking lot pavement of a shopping mall in Windsor,
Ontario. Rehabilitation is a process
that involves pulverizing the asphalt and some of the granular base, compacting
the pulverized asphalt and granular base and adding a layer of hot asphalt mix
on top. The total cost was $431,000
which RioCan (although not required to do so under the terms of the lease)
amortized over twenty years. Metro’s
monthly instalment of this cost was $858 which it paid initially until it
reviewed the matter in 2007/2008. At
that time, Metro disputed this cost, refused to make any further payments with
respect to this cost and set-off the monthly instalments already paid from its
future rent instalments. The lease does
not define what is meant by “accepted accounting practice”.
RioCan argued that this should include not
only GAAP but also tax accounting practices.
It argued that “for there to be a finding that the new asphalt layer was
capital in nature, there must be a future economic benefit to RioCan by way of increased rental income…” The repaving
of the parking lot did not result in any increased rent to RioCan. It did not receive any direct revenues with
respect to the parking lot. Metro, on
the other hand, successfully contended that it is not necessary to “engage in
an exercise of trying to match particular revenues with the improved asset.” The extension of the parking lot’s life and
the significant reduction in on-going operating costs were more than sufficient
for the repaving of the parking lot to be treated as a capital cost. The fact that RioCan amortized the cost over
twenty years suggests, by itself, that the cost is a capital one.
The court dismissed RioCan’s application
and ruled in favour of Metro. The
rehabilitation of the parking lot was a capital expenditure and therefore,
under the terms of the lease, could not be included as an additional rent
charge. RioCan was caught in a difficult
situation. It could not simply continue
to patch and repair the parking lot each year as it had done before 2002 and
charge the full cost to its tenants in the year they were incurred. At some point, however, patching and
repairing becomes ineffective and a rehabilitation strategy must be adopted. By addressing the parking lot issue in a
comprehensive and cost effective manner, RioCan was acting in a commercially
responsible manner. Unfortunately, this
is not relevant when interpreting the lease.
As a matter of fact, the decision indicated quite clearly that “it would
be odd for the internal accounting policies or decisions of the landlord to be
a relevant consideration. Otherwise the
tenant’s rights may change if the lease is assigned to a different landlord
that had different internal accounting policies.” It should come as no surprise, therefore,
that it is the lease that governs regardless of the landlords’ cost efficiencies or
What lessons can landlords learn from this
decision other than to include capital expenditures in the definition of
operating costs? If there is tenant resistance
to broadly worded capital expenditure provisions, the capital expenditure could
be limited to those capital expenditures intended to reduce operating costs. Set out the specific accounting standard to
follow. GAAP may not always be
appropriate. Include a provision to
preclude tenants from objecting after the expiry of a certain period.
Counsel for RioCan has indicated that this
case will be appealed. Stay tuned.
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