There is a common misconception about having to reserve the last day of a term when drafting a sublease. This practice is often intended to illustrate that the parties intended to sublet the subject premises, as opposed to assigning the lease.
In 2019, the Ontario Court of Appeal (“OCA”) rendered a decision in V Hazelton Limited v. Perfect Smile Dental Inc., wherein the OCA provided a comprehensive analysis of the case law governing subleases and assignments that dates back “hundreds of years”.
The OCA’s decision highlights the differences between an assignment of lease and a sublease. In an assignment, the third-party becomes the tenant of the landlord, creating a privity of estate between the landlord and the third-party; at such time, the landlord’s privity of estate with the original tenant/assignor comes to an end, but the privity of contract remains. A sublease, on the other hand, does not create a direct relationship between the subtenant and landlord, therefore there is no privity of estate or privity of contract between them.
- The appellant, V Hazelton Ltd. (“Hazelton”), leased commercial premises from the respondent, Perfect Smile Dental Inc. (“Perfect Smile”)
- The lease afforded Hazelton the right to renew the lease for an additional term of five years upon expiry of the initial seven-year term
- Hazelton proceeded to sublease the entire premises to a third-party, Outhere by Marcus Chaves (“Outhere”), but failed to reserve the last day of the head lease term
- Hazleton purported to exercise its option to renew the lease, but Perfect Smile maintained that it no longer had that option, as the lease had been assigned to Outhere
- The OCA held that Hazelton had rightfully exercised its option to renew the lease and required Perfect Smile to give possession of the premises to Hazelton
As part of the OCA’s analysis, consideration was given regarding the impact of failing to reserve the last day of the term in the head lease. The OCA maintained that by failing to reserve the last day or some other time period at the end of the term, a head lease will be deemed to have been assigned, except for the applicability of the Commercial Tenancies Act (Ontario) (“CTA”) (most notably, Section 3) and the principles of contract law.
The OCA interpreted Section 3 of the CTA to mean there may be a sublease regardless if the last day of the head lease is reserved, provided that there is sufficient evidence to show that it was the objective intention of the parties to create a sublease, not an assignment. In this case, the OCA declared that Hazelton did in fact sublease the premises to Outhere, as Hazelton was able to substantiate the parties did not intend an assignment; specifically, the OCA considered a provision in the sublease, which confirmed that Hazelton was under no obligation to renew the head lease in favour of Outhere and that the subtenant further acknowledged that they were not entitled to such right of renewal or extension.
The decision also provides alternate examples as to how a tenant can preserve its reversionary interest to prevent an assignment, which includes:
- a sublease with a more restricted option to renew than the option set out in the head lease
- having the subtenant specifically acknowledge they do not retain a reversionary interest in the nature of the last day of the term of the head lease
- subleasing only a portion of the premises demised under the head lease
In summary, while it is not necessary for a tenant to reserve the last day of the term when drafting a sublease, it would be good practice to do so to avoid any doubt or uncertainty as to the objective intention of the parties.