The Limits of Exculpatory Clauses in the Commercial Leasing Context: To What Extent Can Misrepresentations be Contracted Around?
The Ontario Court of Appeal’s decision in DLG & Associates Ltd. v Minto Properties, 2015 ONCA 705 [DLG], raises important issues around the limits of “exculpatory” and “entire agreement” clauses in leasing agreements: namely, how far they can be relied upon by a landlord who knowingly withholds key information from a tenant on the state of repair of the building it leases. The significance of withholding such information in DLG was that the tenants, D.L.G. & Associates Ltd. (“DLG”), allegedly relied on the assertions made by Minto Properties (“Minto”), pertaining to the building’s sewer system, to waive certain legal rights. After the sewer system backed up a second time, again causing severe damage to the restaurant being operated on the premises, DLG was in effect put out of business.
After DLG brought suit against Minto for breach of contract, ordinary negligence and negligent and fraudulent misrepresentation, Minto invoked the exculpatory clause contained in the lease and a “covenant to insure” provision. The latter required DLG, as tenant, to obtain and maintain “all-risks” insurance, which meant that DLG was contractually taking responsibility for any breaches of contract or acts of negligence committed by Minto. In effect, it functioned like an exculpatory clause. It was unclear, however, how far these provisions could be stretched to immunize Minto from failing to disclose that the sewer system was undersized and contravened building code standards.
Of further importance was a release that Minto signed after the first sewer back-up occurred. After having its business destroyed, it claimed through its insurer and rebuilt its restaurant. Due to the resulting loss of income, it renegotiated a period of reduced rent with Minto. Every other term in the original agreement remained in effect, except that Minto required DLG to sign a release, exculpating it from all future liability for negligence or breach of contract. The factual record shows that Minto, at this point, failed again to disclose the defects in the sewer system. The sewer backed up a second time and destroyed the restaurant again, this time putting DLG out of business.
Minto brought a motion to have DLG’s action dismissed for failing to disclose a reasonable cause of action. The motions judge held that it was plain and obvious that the pleadings were not viable except for the allegation of fraudulent misrepresentation which stood a chance at trial. The Court of Appeal disagreed. It held that both negligent and fraudulent misrepresentation were viable arguments that should proceed accordingly.
Issues & Reasoning
However, several problems arise from the analysis of both courts. The Court of Appeal draws a seemingly arbitrary distinction between the “covenant to insure” clause in the lease and an ordinary exculpatory clause. It holds, first, that the covenant to insure is effectively defeated if interpreted only as shifting responsibility for Minto’s negligence to DLG and its insurer. It must also by necessity, shift responsibility onto DLG for Minto’s breach of contract because Minto’s potential negligence overlaps with it breaching its contractual obligations to repair and maintain the sewer system. This is consistent with the Supreme Court of Canada’s decision in Tercon Construction Ltd. v British Columbia (Transportation and Highways),  1 SCR 69 [Tercon], which held that liability for breaches of even fundamental terms in a contract can be exculpated with a properly constructed clause. Yet, the Court of Appeal in DLG then goes on to conclude that such an arrangement should be treated differently than an ordinary exculpatory clause and that the analysis from Tercon should not apply to the facts at hand.
While the motions judge did contemplate the above interpretation, it left the issue open for a future trial or motions court to decide. By holding as it did however, the Court of Appeal constrained the future judge from applying the Tercon principles to determine the limits of the covenant to insure, which admittedly functions very much like an ordinary exculpatory clause.
The Tercon decision makes it clear that courts should favor a presumption that an exculpatory clause excludes all breaches of contract or acts of negligence that arise during the course of a contract. It sets out three criteria for determining whether such a clause should not to apply: 1) whether as a matter of interpretation the exclusion clause even applies to the circumstances; 2) whether the exclusion clause was unconscionable at the time the agreement was made; and 3) whether the Court should refuse to enforce a valid exclusion clause due to an overriding policy concern.
Treating the covenant to insure as an exculpatory clause, the motions court went through the exercise of applying the Tercon principles and concluded that DLG’s claims for breach of contract, negligence, and negligent misrepresentation would be properly excluded. It further treated the release signed after the first flood as an exculpatory clause and equally concluded that the above arguments, except for the fraudulent misrepresentation claim, would fail at trial. However, the motions judge also upheld the possibility of an economic duress argument surrounding the release.
The Importance of Applying the Tercon Analysis and Finding Limits on the Exculpatory Clauses
The Court of Appeal took a different approach with respect to the enforceability of the covenant to insure and the release. Rejecting the applicability of the Tercon principles, the Court held that DLG’s allegations were founded in tort, outside of the obligations created by the lease. Thus, DLG had a viable claim for misrepresentation that went to contract formation, both with respect to the covenant to insure and the release. If proven, this could render either agreement void ab initio.
Interestingly, the Court of Appeal reasoned that if the misrepresentations occurred outside of the agreement then a claim for negligent misrepresentation should also be allowed to stand. Of course, Minto plead in anticipation of this argument that the “entire agreement” clause in the lease forecloses such a claim. The Court of Appeal however held that it was not clear whether such a clause applied prospectively to misrepresentations made after the lease was entered into, nor would it likely apply to inducements made fraudulently.
While such a finding gets both the negligent and fraudulent misrepresentation claims past the threshold of summary dismissal, it shifts focus to interpreting the applicability of the entire agreement clause to the misrepresentations made. This risks foreclosing a helpful analysis of whether fraudulent or negligent misrepresentations can be immunized by an exculpatory clause or a provision that operates just like one.
As this case progresses to trial, it is likely that Minto could raise the argument that although it made representations to DLG that it had repaired the sewer on which Minto relied to reopen its restaurant, DLG acted unreasonably in relying on such a statement. The basis would be that DLG bore the risk of Minto breaching its obligation to repair under the agreement.
However, the first step of the Tercon analysis, addressing whether as a matter of interpretation the exclusion clause even applies to the circumstances, would be a helpful inquiry into determining what scope of conduct was intended by the parties to fall under the exclusion clause. After the first flood, when it became clear to both parties that DLG was having trouble obtaining flood protection from its insurer, it is reasonable to infer that the parties did not intend for Minto to be exculpated for failing to disclose key information, whether intentionally or through negligence, that would have influenced DLG’s decisions on whether to reopen the restaurant.
While the outcome of this matter remains to be seen, it is possible that the Court of Appeal in its ruling on the motion appeal constrained the analysis in a limiting way. Applying the first step of the Tercon analysis could establish necessary limits on the exculpatory clauses in these circumstances and could provide clearer guidance on the matter for future cases. However, the Court of Appeal decided—in a seemingly arbitrary fashion—that the clauses in question were not in fact exculpatory clauses.