The “Net Net Net” Clause in Commercial Leases: Intent Clause or Lip Service?

February 2008

The “Net Net Net” Clause in Commercial Leases: Intent Clause or Lip Service?

bouton-vers-francaisJulie Lanteigne
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Is your lease "net net net" or "absolutely net"? Is there a legal difference between these various labels and is there any use in including a clause in a lease to the effect that the lease is "net net net" to the landlord? We will try to answer these questions with an overview of recent caselaw on this topic.

Nomenclature and Intent Clause

The drafters of leases, certainly not lacking in flair, do not seem to have run out of expressions for describing a lease in which the landlord has the tenants assume all of the operating costs for the immovable being released. Among the expressions used, we have seen the following:

  • "Net net lease"
  • "Net net net lease"
  • "Net net net net lease"
  • "Absolutely net lease"
  • "Entirely net lease"  

Many leases contain an intent clause in which the tenant declares or acknowledges that the lease is "net net net" (or some variant thereof) to the landlord. Do such clauses have any legal effect or are they merely wishful thinking? By presenting the caselaw we have identified, we hope to shed some light on this matter.

Caselaw

161718 Canada Inc. v. Société Radio Canada, [1998] A.Q. no. 1997 (Québec Sup. Ct.)

In this case, the landlord attempted to include, as part of its operating costs, the salary paid to the employee it had assigned to manage the building.
 
The lease contained an intent clause in which the tenant acknowledged that the lease was to be net net net to the landlord.
 
The statements of account and invoices setting out the operating costs were submitted as evidence.
 
Despite the existence of the intent clause, the Court considered that the words "net net net" did not have the effect of compelling the tenants to pay costs related to the landlord, unless such costs were expressly provided for in the lease.
 
In particular, the Court stated the following as regards the intent clause:

[translation] "The fact that the lease entered into between the parties uses the words net net net does not mean that the landlord is justified in including major expenses which were not discussed between the parties and which, for good reason, are not mentioned in the lease."

It is clear, in this decision, that the intent clause and the use of the label "net net net" had little impact on the Court's decision.
 
The Court further stated:

[translation] "In order to conclude that the parties' intent was to include expenses that are not specified in the lease, there must be some evidence allowing the Court to give preference to this argument put forward by the landlord; however, this issue does not even seem to have been discussed."

Thus, it would seem that if a landlord can prove, with appropriate evidence, that the intention of the parties was truly to include such an expense in the operating costs, a court may allow its inclusion.

Skyline Holdings Inc. v. Scarves and Allied Arts Inc., [2000] J.Q. no 2786 (Québec C.A.)

In this case, the landlord attempted to include, as part of its operating costs, an amount of $270,000 spent on roof repairs, arguing that the lease was a "net" lease and, therefore, all expenses, other than capital expenses, were to be included in operating costs and paid by the tenants. In order to include this expense in operating costs, the landlord relied on the following catch-all clause:

"all reasonable costs ordinarilly (sic) chargeable against income from the building"

The Court referred to the fact that the general terms of a contract must be limited to what it appears that the parties intended to include (1431 C.C.Q.).
 
If an expense a landlord is attempting to include in operating costs has not been specified, such a clause will be insufficient to allow the inclusion of that expense.
 
In particular, the Court added the following:

[translation] "…the type of expenses that the tenants agreed to pay under their lease does not include expenses whose purpose is to give the landlord the benefit of having a building whose condition, at the end of the lease, has been improved at the expense of the tenants. The cost of replacing the roof is not an expense that can reasonably be considered to form part of the operating costs that should be assumed by a tenant, unless the lease contains a specific clause to that effect.

Even in so-called "net, net or net net net" leases, the expenses attributable to the tenant may vary from one lease to another; thus, having a clear clause is essential … In a double net or triple net lease, even if the landlord leases the building in an "as is" condition, without undertaking to pay the maintenance and operating costs …, the landlord can nevertheless not require the tenants to give back a building that is in new condition."

In addition, in this case, the landlord also attempted to include, as part of the operating costs paid by the tenants, administration expenses equal to 15% of the cost of salaries related to the administration of the building.
 
Evidence was presented to show that the landlord had begun to include these administration expenses in operating costs only during the course of the lease, following the advice of its accountant who had indicated that such expenses were usually invoiced to tenants. The Court had no doubt. The parties' conduct demonstrated that the parties had not discussed these expenses or agreed to include them at the time the lease was entered into. It therefore dismissed the landlord's claim.
 
In this case, as in the previous one, notwithstanding the fact that the lease was labeled as a net lease and despite the existence of the catch-all clause, the Court disallowed the inclusion of any expense not specifically listed in the lease.

Société Lidesign Inc. and Entropal Inc. v. 2970-4020 Québec Inc. and Marie-Jolimise Gourdet and André Riendeau, [2003] J.Q. no 5989 (Québec Sup. Ct.)

In this case, the lease provided that it was to be net net and that the tenant would pay its proportionate share of the operating costs, up to a maximum of three dollars ($3.00) per square foot of the area of the premises, adjusted on the basis of the cost of living as determined annually by Statistics Canada.
 
The landlord, wishing to include expenses that would exceed the $3.00 per square foot maximum, argued that there was an inconsistency between a "net net rent" and such a maximum, and that the wording "net net rent" should take precedence over the maximum, such that all the expenses were to be included in the group of expenses comprising the additional rent.
 
The Honourable Justice Bernard Flynn, did not share this opinion:

[translation] "The Court cannot accept the landlord's allegation to the effect that the expression "net net" means that the tenants were to assume their full proportionate share of the items listed in the clause. As Jean–Pierre Riel, pointed out in his book Louage commercial: un mode en évolution, Les aspects financiers du bail commercial, Carswell 2000, page 29 et seq.: [translation] "The labels "net lease, net net lease, net net net lease, net net net net lease" may take many forms." Moreover, the Court does not see why the parties could not agree to set a maximum amount for the obligation."

He also stated that he did not see any inconsistency, because the clause would apply if the tenant's proportionate share was less than $3 per square foot, in which case the tenant would be entitled to a reduction. In the contrary situation, the proportionate share would be limited to $3, indexed as provided for in the lease.
 
Absent evidence that there had been an error in the drafting of the clause, absent evidence that the contract did not reflect the intention of the parties, and given that the wording of the clause was neither ambiguous nor contradictory, the Honourable Justice Flynn refused to amend the terms of the contract. The lessor's application to include the tenant's full proportionate share was dismissed and the clause was applied as is, with the $3.00 ceiling being upheld.

GE Capital Realty Management Inc. v. Zellers Inc., [2001] J.Q. no 2223 (Québec C.A.)

In this case, the landlord attempted to obtain the reimbursement of its tax on capital through the tenant's proportionate share. The landlord was confident, because its lease contained a very detailed intent clause to the effect that the lease was to be net net net to the landlord and, in addition, the lease stipulated that the tenant was to pay the tax on capital. The clause reads as follows (emphasis added):

7. PAYMENT OF TAXES, ASSESSMENTS, ETC.
 
Without limiting the generality of the foregoing paragraph 6, Tenant shall, throughout the Term and any renewal thereof, be responsible and pay to the complete exoneration of Landlord the following taxes, costs and expenses:
 
All taxes, property taxes, municipal taxes, tax on capital, … that may be levied, rated charged or assessed against the Property and/or all equipment and facilities thereon or therein by Landlord… whether such taxes, rates duties or assessments are charged by a municipal, parliamentary, school, or any other body of competent jurisdiction."

Nonetheless, the Court of Appeal refused to include the tax on capital in the operating costs.
 
Despite the fact that the lease provided for the payment of the tax on capital, the method for attributing this tax had not been set out in the lease.
 
Tax on capital is not a real estate tax; it is a tax assessed on the basis of the owner's specific characteristics and the corporation's overall capital. The lease did not provide a method for attributing the tax on capital.
 
What effect will this decision have on clauses providing for a tenant's participation in the payment of such a tax, where the lease stipulates that the allocation of the tenant's share is to be determined by the landlord? As with any clause granting discretion, the landlord will have to exercise the discretion reasonably in order for the courts to support it.
 
Given that any party invoking or seeking the enforcement of a specific right has the burden of establishing the existence of that right, the landlord will have to prove that the method used was reasonable or usual in the industry and that the tenant agreed to the application of such a method, despite the fact that the method was not specifically described in the lease.

Conclusion

Clearly, intent clauses are not particularly helpful! Therefore, prudence dictates thoroughness.  

None of the cases sheds light on the exact meaning of the various labels or the differences between them. They seem to be industry labels that are inaccurate, vary from one lease to the other and have no legal value.  

Thus, rather than focusing on drafting a perfect intent clause so as to obtain a "net net net" lease, it is more important to focus on the clauses setting out the operating costs and taxes in order to ensure that they include or exclude, as the case may be, the costs to which the tenant will be required to contribute through its proportionate share. If there is any ambiguity regarding an expense not specified in the lease, the landlord will have to prove that the mutual intent of the parties at the time the lease was entered into was to include that expense.

The rules pertaining to the interpretation of contracts set out in the Civil Code of Québec favour an interpretation that gives effect to each clause of the contract. Based on the above cases, and other similar ones, it would appear that the courts have disregarded these rules of interpretation. In the undersigned's humble opinion, this type of intent clause, whose purpose is to provide a solution for a number of unforeseeable situations, is of limited usefulness. It is up to the contracting parties, and, more specifically, the drafter of the lease, to think ahead. This task is all the more formidable, if one considers that, in Québec, a lease may have a term of up to 100 years!

This bulletin provides general comments on recent developments in the law. It does not constitute and should not be viewed as legal advice. No legal action should be taken on the basis of the information contained herein.

 

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