Ontario Court of Appeal Clarifies Option-to-Purchase Clause

The recent case of 1785192 Ontario Inc. v. Ontario H Limited Partnership, 2024 ONCA 775 (Ontario H Limited Partnership) demonstrates that a purchaser who fails to tender the full purchase price required under an option-to-purchase clause may be in material breach of the contract of purchase and sale — even if that amount is in dispute.

Background

In Ontario H Limited Partnership, the appellant landlord leased two commercial properties to the respondent tenant as part of an asset purchase agreement, which included an option for the tenant to purchase the properties at a price determined by the midpoint of each party’s fair market value appraisal. After the tenant exercised its option-to-purchase, the landlord acknowledged receipt of the notice and advised that appraisals must be obtained based on the highest and best use of the properties.

The appraisals obtained by each party differed substantially:

• The landlord’s appraisal was C$31,200,000, assuming rezoning for a residential condominium
• The tenant’s appraisal was C$11,746,000, based on current zoning as a commercial property and auto dealership

The Decision

The Ontario Court of Appeal did not disturb the application judge’s finding that both appraisals were valid, given the mechanism in the lease accounted for each party seeking an appraisal using reasonable assumptions that were most favourable to that party. Neither the substantial difference in appraisal values nor the landlord’s highest and best use assumption meant there was necessarily a methodological error in one of the appraisals. The purchase price was, therefore, the midpoint between the two appraisals.

Despite the landlord agreeing to the midpoint of C$21,473,000, as required by the option terms, the tenant refused to accept the validity of the landlord’s appraisal and tendered only the lower value of C$11,746,000, withholding the difference in trust with its lawyer pending the outcome of future litigation or arbitration. The landlord refused to close with the tenant tendering only part of the purchase price, which prompted the tenant to seek specific performance and the landlord to apply for an order declaring the option-to-purchase null and void.

The application judge ruled in favour of the tenant, finding the partial tender was adequate and not a breach of its obligations. The Ontario Court of Appeal overturned this lower court decision, holding that the tenant had materially breached the contract by not tendering the full purchase price established using the methodology specified in the option. The Court of Appeal emphasized that the option clause set a fixed purchase price, and the tenant’s unilateral withholding of part of that amount, even in the face of a dispute, was a material breach of the contract that warranted the landlord’s refusal to convey the property.

The tenant’s request for relief from forfeiture was also denied since the tenant failed to establish that such relief is available on failure to tender the full purchase price and that it ought to be ordered in the circumstances of the case. The Court of Appeal expressed that if the tenant, a commercially sophisticated party with legal representation, wanted to protect its position, it could have tendered the full purchase price and litigated the issue afterwards.

Takeaways

The following are key takeaways from this case to consider:

1. Tender of Full Purchase Price: When the purchase price is fixed by a mechanism in the option clause, a purchaser risks being found in material breach of the purchase agreement when it unilaterally withholds a portion of the purchase price, even if there is a dispute over the amount owed.
2. Pay First, Litigate After: In applying the above principle to other contexts where money is owed under a purchase agreement or lease, it is likely safer for the party to pay its obligation in full and then try to recover the disputed amount through litigation or arbitration afterward.
3. Boundaries for Appraisals and Fair Market Value: To better protect against appraisal disputes, parties can agree on key assumptions/parameters beforehand (such as whether the property should be appraised based on its highest and best use versus its current use) and on a process for resolving significant appraisal discrepancies (such as a third independent appraiser).

For more information, please contact the author of this bulletin or any other member of our Commercial Real Estate group.