Lease Transfer Provisions & Corporate Tenant

2 juillet 2013 | Savvas Kotsopoulos

( Disponible en anglais seulement )

Do mergers/amalgamations trigger consent rights? 

It is not uncommon for a national corporate tenant (especially those with international roots) to be part of a complicated organizational structure which can include cross-border elements.  Tax and securities-driven reorganizations and restructurings are also not uncommon in these contexts and are frequently accomplished through amalgamations. Accordingly, leasing practitioners acting for both landlords and tenants have reason to tread cautiously when considering the consequences of a corporate tenant’s amalgamation.  The age old question in this regard is whether an amalgamation is in fact a transfer of the leasehold estate which engages the transfer provisions of a lease. 

The leases of most sophisticated landlords typically contain extensive provisions which contractually prohibit or restrict the tenant’s ability to amalgamate without the landlord’s consent in the same way that an assignment of the lease is restricted.  Similarly, sophisticated tenants will seek to ensure that they are afforded sufficient flexibility and exemptions from the landlord’s consent requirements in order to undertake necessary reorganizations.  Such exemptions will often be made contingent upon the landlord being reasonably satisfied that the amalgamated tenant’s financial covenants and continuing management and quality of business operations is not negatively affected.

In Canada, the manner in which two or more companies amalgamate is governed by corporate statute.  For example, the Ontario Business Corporations Act provides at section 174 that “[t]wo or more corporations, including holding or subsidiary corporations, may amalgamate and continue as one corporation”.  The Canada Business Corporations Act contains a similar provision, as do other provincial statutes.  It is well-accepted practice amongst corporate practitioners that an amalgamation does not extinguish the existence of any of the amalgamating corporations but rather that the deliberate use of the word “continue” suggests that they become one.  This theory was described in the Supreme Court of Canada’s decision in R. v. Black & Decker Manufacturing Co., [1975] 1 SCR 411 (Black & Decker) as two rivers coalescing to create a homogenous whole, like a river formed by the confluence of two streams.  As a result, the property and rights of each predecessor corporation continue to be the property and rights of the amalgamated corporation. While an amalgamation does not effect a transfer or assignment of the lease, the amalgamated company possesses (but does not acquire) the property of the amalgamated companies.

Black & Decker has been routinely followed.  The notable exception is the decision of the Saskatchewan Court of Queen’s Bench in Crescent Leaseholds Ltd. v. Gerhard Horn Investments Ltd., [1983] 1 W.W.R. 182 (B.C.S.C) (Crescent Leaseholds).  In dismissing the “confluence of streams” theory asserted by the Supreme Court in Black & Decker and ignoring the principle of stare decisis, the court held that an amalgamation breached a restriction in a lease which prohibited an assignment by operation of law. Crescent Leaseholds has generally not been followed, and it appears safe to conclude that, absent a prohibition or restriction against amalgamations in the lease itself, the amalgamation of a tenant with another corporation will not in and of itself constitute a default under a non-assignability provision of a lease.

It follows that landlords who wish to prohibit their tenants from amalgamating must expressly so provide in the lease. If a lease merely states that an assignment thereof is prohibited and nothing more, the courts will not be inclined to read in an expansion of this restriction, and amalgamating without consent will not breach the transfer restrictions. That said, while the door has largely been closed on the arguments underlying the Crescent Leaseholds decision, it remains possible for a landlord to argue that a prohibition in a lease against assignment by operation of law extends to amalgamations.

The analysis of the lease assignment provisions in the context of an amalgamation should not end at this point.  Even if an amalgamation is not restricted by the terms of the lease, where the steps of the amalgamation involve the “movement” of the amalgamated entity within its corporate structure or into the structure of another corporate family (as may be the case in the context of a merger and acquisition), restrictions on a change of control could be triggered. For example, where the majority shareholders of the tenant pre-amalgamation become the minority shareholders of the tenant post-amalgamation, the change of control provisions of the lease could also apply.

Many leases capture “effective changes of voting control”.  What does this mean?  Does it capture indirect changes such as changes at the parent level? 

From a landlord’s perspective, a change in the control of a corporate tenant should be regulated in the same manner as a transfer of the lease. Otherwise, the tenant could successfully accomplish the equivalent of a transfer of the lease (and circumvent the restrictions therein) through a transaction which transfers control of the tenant, and by extension the leased premises, to a third party. 

Most sophisticated leases will expressly prohibit or restrict a change in the control of a corporate tenant.  These provisions often deem a change of control to be a transfer which triggers the landlord’s consent rights in the same way that would apply to an assignment of the lease, for example.  However, there is considerable variability in the wording of change of control clauses in contemporary commercial leases.  Variations range from short clauses which simply prohibit a change of control of the tenant without any expansion or definition as to what any of these terms mean, to very detailed provisions which define control, address changes of control amongst the tenant’s related entities and elsewhere in its corporate structure, together with other transactions which could affect the control of the tenant.   

One of the challenges in dealing with the less explicit change of control provisions is determining whether the change of control clause is meant to cover the “bottom end” or the “top end” of the tenant’s corporate structure. In other words, consideration must be given to whether the change of control clause is intended to restrict not only a direct change of control of the tenant but also changes in the control of the tenant’s direct parent, related entities and/or its ultimate parent. 

In Canada, little has been written in the commercial leasing context on the interpretation of change of control provisions, and there is limited direction from the courts on this topic.  In practice, the reference to “control” (to the extent not defined in the lease) appears to be most commonly understood amongst leasing practitioners as de jure (or legal) control, supported with reference to definitions of control in corporate statutes and/or the Income Tax Act (Canada).  Accordingly, the percentage of ownership of the voting shares in relation to the holdings of other shareholders; shareholder agreements which impact the holding of a casting vote; and the transfer or pledge of shares by way of security are all important factors in determining control and changes thereto.  Although less common, some leases are drafted broadly enough (including express references to changes in the tenant’s management) to suggest that a de facto (actual) control test must be considered in those cases.

The use of the word “effective” to describe the concept of control is often a source of consternation for those reviewing this type of clause.  As noted above, the case law offers little guidance as to the meaning of “effective” in this context.  A common view amongst leasing practitioners is that the use of the word “effective” brings within the transfer restrictions indirect changes of control of the tenant (perhaps of a related entity upstream in the tenant’s corporate structure), if in fact the net effect of such transaction impacts the control of the tenant. Accordingly, in the case of a conventional parent/subsidiary relationship, a transaction involving a change in control of the tenant’s parent entity would likely necessitate the landlord’s consent.  Those considering whether consent is required in connection with a re-organization, merger, financing or other transaction impacting the tenant’s organizational structure will need to understand the consequence of these transactions vis-à-vis the control of the tenant when interpreting these lease provisions.

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