Nightmares in Commercial Real Estate Transactions

It’s that time of year when pumpkin sales go soaring, horror movies sell out at the theatre, and everyone is seemingly dressed up as a vampire or a zombie. To mark the spookiest time of year, this Halloween, Houser Henry & Syron LLP presents…

Nightmares in Commercial Real Estate Transactions

By Melissa Nowak

The following nightmares can happen to anyone, whether you are awake or asleep! 

Nightmare #1

The Spine-Chilling Sealed Contract

Witchy Wendy and a consortium of ghouls owned a commercial building that leased the ground floor space to a children’s day care.   This savvy but gruesome looking business witch, feared that her daycare tenant would be spooked if it knew that she and her ghoulish associates were the daycare’s landlord. So, under the name 666666 Ontario Inc., she set up a bare trust to hold title to the property for the benefit of the true owners.  But, this, is not even the scary part!

To obtain some capital for their broom manufacturing business, Witchy Wendy and her associates of ghouls mortgaged the commercial building.  The lender, Innocent Ian, was satisfied that the rent from the daycare would sufficiently service the loan and entered into the mortgage.  Innocent Ian, however, failed to realize that 666666 Ontario Inc. was a bare trust, and as a result, he did not obtain an agreement binding the beneficial owners to the mortgage as a part of his security package.

As it turns out, the daycare tenant struggled to pay rent each month and defaulted on its lease.  With no rental payments coming into 666666 Ontario Inc., Witchy Wendy and her ghouls were unable to make their loan payments to Innocent Ian.  Innocent Ian took steps to enforce the security under the mortgage but learned, to his horror, that:

  • he had entered into a mortgage with a bare trustee, 666666 Ontario Inc., and
  • the principals, Witchy Wendy and her ghoulish associates, were shielded from liability under the mortgage.

The “sealed contract” rule” prevents an undisclosed principal from being sued under a sealed contract entered by an agent, the bare trustee, and the Land Registration Reform Act deems a mortgage to be a sealed contract, regardless of whether it is signed under seal.  As such, Innocent Ian had no recourse against the beneficial owners of the building, Witchy Wendy and her ghoulish associates. Although Innocent Ian did have recourse against the land, its value had plummeted after the vacancy of the daycare tenant. 

Don’t get spooked like Innocent Ian.  Perform due diligence on the borrower entity when entering into a mortgage!

Nightmare #2

The Terrified Tenant

Gary Goblin built a successful jewelry business.  He started the business in his very own dungeon.  He grew to be so successful that he needed to hire employees and lease space on Main Street, in the quaint downtown business district of Deadman’s Landing. 

Gary Goblin knew jewelry; his cloudy but astute eye could accurately assess carat, cut, color and clarity in an instant.  But Gary Goblin knew nothing about real estate.  When Lucifer Landlord presented him with a lease for his new retail space, Gary Goblin simply held his breath and signed.

Gary Goblin’s business continued to thrive, and he built an excellent reputation!  But Gary Goblin wasn’t getting any younger, and he longed to get back to Europe to visit his goblin cousins before he was too worn down to travel.  So, he considered selling his business. 

Upon learning that Gary Goblin was considering selling his business, a giant retail jewelry conglomerate, Demon Diamonds, immediately made an offer.  The offer was glorious. It was more than what Gary Goblin could’ve asked for and he accepted the offer without hesitation.  One condition of the offer was that the lease to Gary Goblin’s retail space on Main Street be transferred to Demon Diamonds as it desperately sought retail presence on that busy retail corridor in Deadman’s Landing.  Demon Diamonds began its due diligence and realized that Gary Goblin’s lease did not:

  • have a right of assignment in the event of a sale of his business, or sale of the shares of his business; and
  • have rights of transfer without the consent of the Landlord, which consent could be withheld in their sole, subjective discretion. 

Because he was a good tenant, Gary Goblin thought Lucifer Landlord would cooperate, so he asked him for consent to assign the lease to Demon Diamonds.  Unfortunately, Gary Goblin was wrong!  Lucifer Landlord did not give his consent and stated that he would only consent to the assignment of the lease if the rent doubled.  When Gary Goblin proposed this idea to Demon Diamonds, its board became spooked. They wondered whether Gary Goblin was as sophisticated of a business goblin as they first thought and realized there may be more risk than the anticipated.  Because Gary Goblin could not assign the lease, an important component of the deal, Demon Diamonds terminated their offer.  Dejected and angry, Gary Goblin hobbles up and down Main Street scaring children as retribution to Lucifer Landlord, who owns most of commercial buildings along Main Street. 

Don’t be a Gary Goblin. Have a legal professional review your commercial lease!

The moral of these spooky tales is to speak with a commercial real estate lawyer before entering into any commercial real estate transaction.  Our firm can help you identify issues before they become your nightmare.

The End

Happy Halloween from the team at Houser Henry & Syron LLP.