February 2010

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Subrogated Claims by Insurers in Commercial Leases (Part VI) - Update on 1044589 Ontario Ltd. v. AB Autorama Ltd.

In several previous posts we have addressed recent cases relating to subrogated claims by insurers in commercial leases. A subrogated claim refers to the claim by which an insurance company seeks recovery of the amount it pays to a policy holder from a third party who may have caused the loss.

In October of 2008, we commented on the Ontario Superior Court of Justice’s decision in 1044589 Ontario Inc. c.o.b. Nantuckett Business Centre v. AB Autorama Ltd. (2008 CanLII 394435 ONSC) (“Autorama”). This post follows a reversal of that decision by the Ontario Court of Appeal.

In Autorama, the landlord and tenant signed an Offer to Lease for an auto body shop in a strip mall. The Offer provided that the tenant would pay its proportionate share of the operating costs of the building, which included the cost of insuring the building. While the tenant was required to contribute to the cost of insurance, the Offer did not contain a corresponding covenant of the landlord to obtain insurance.

A fire started in the tenant’s unit and caused damage to the building and its contents, as well as an interruption of business and a loss of profits for the landlord. The parties brought a motion to the Ontario Superior Court of Justice to decide whether the terms of the Offer permitted the landlord to sue the tenant for damages (and its insurer to make a subrogated claim standing in the shoes of the landlord) or whether, when it included insurance as part of the cost of the tenant’s proportionate share of the cost of the premises, the landlord assumed the risk of damage by fire, and thus could not sue the tenant for damages arising from the tenant’s negligence.  The motions judge had held that under the terms of the Offer, the Tenant assumed the risk for any losses caused by the tenant’s negligence and that the Landlord was not precluded from pursuing a claim against the tenant.

The tenant appealed the decision.

The Ontario Court of Appeal allowed the appeal, set aside the order of the motions judge and ordered that the landlord is precluded from maintaining its claim against the tenant.

In reaching its conclusion, the Court of Appeal held that Ross Southward Tire Ltd. v. Pyrotech Products Ltd., [1976] 2 S.C.R. 35 (“Ross”), a Supreme Court of Canada case was in substance identical to the present case and dispositive of the appeal. Ross had been considered by the motions judge, but was incorrectly distinguished on the basis that the landlord had covenanted to insure the property against fire loss (when in fact it had not).

The lease in Ross stated that “the lessee shall pay all realty taxes including local improvements and school taxes, electric power and water rates and insurance rates immediately when due.” The Supreme Court held that the obligation to pay all insurance rates included fire insurance and that because the lessee paid for insurance, it received the benefit of insurance coverage.

The same reasoning was applied by the Court of Appeal in the present case. The provision in the Offer requiring the tenant to contribute to all costs of insurance had the effect of allocating the risk of fire loss to the landlord.

The decision of the Court of Appeal is more in line with the majority of the case law and the generally accepted thinking on the subject. The landlord had insurance which the tenant paid for, so why should the tenant not benefit from that?

This case also illustrates the hazards of parties choosing to live under the terms of an offer to lease, rather than proceeding with a lease. It is likely that the parties here would have turned their minds more fully to insurance obligations and allocation of risk during negotiation of the lease terms and perhaps avoided the litigation.

Bob Fraser