Change of control provisions are a common feature of commercial leases, yet, in practice, their meaning and operation remain a recurring source of uncertainty. A recent review of the available Canadian jurisprudence and commentary confirms what many practitioners may already suspect: while the substance of change of control provisions may not vary significantly from lease to lease, the interpretation and application of such provisions is fact dependent and complex. While some commentary exists, the legal landscape has not materially evolved in recent history. Given the importance of such provisions, particularly for corporate tenants that may be subject to reorganizations and restructurings, it is worth revisiting the conversation and considering future practice when it comes to drafting change of control provisions.
This blog examines how change of control provisions are commonly understood in Canadian commercial leasing, the limited guidance offered by the courts and the competing interests at play in the negotiation of such provisions. It concludes with practical drafting considerations for change of control language in the context of transfer provisions in commercial leases.
Why Change of Control Matters in Commercial Leasing
A change of control provision, which is typically found in the transfer or assignment section of a commercial lease, outlines the conditions and consequences triggered when a transfer of ownership or a significant change in the controlling interest of a tenant is contemplated, expected to occur or actually occurs. Generally speaking, a change of control provision may either provide that a change of control of the tenant is considered a transfer requiring landlord consent or is not considered a transfer requiring a landlord consent (though often still requiring notice to the landlord).
A change of control provision that requires landlord consent is designed to prevent a tenant from indirectly completing a transfer that is otherwise meant to be prohibited under the lease. A prohibition on a change of control without landlord consent provides the landlord greater oversight and control over the tenant entity bound by the lease, including over its ownership structure (i.e., parent company, shareholders or other controlling interests). Without a requirement for consent, a tenant could potentially circumvent certain assignment restrictions. As a landlord's decision to lease is often based on considerations such as the tenant's financial covenant, creditworthiness and the nature of their business operations, allowing a tenant to transfer control without prior approval could leave the landlord with a "new" tenant that the landlord neither evaluated nor approved.
Conversely, a change of control provision that does not require landlord consent allows a tenant to avoid significant constraints on corporate activity. The tenant may undertake mergers, internal reorganizations, estate planning related activities and private equity transactions, which could otherwise trigger a change of control provision (even if the underlying business remains stable and creditworthy).
It is also important to consider the consequences of failing to provide notice of a change of control, even where consent is not required. Depending on the lease language, a failure to notify the landlord may itself constitute a breach, potentially triggering default provisions or at minimum, creating uncertainty about the tenant's compliance with the lease. Practitioners should consider whether the notice obligation is a condition precedent to the permitted change, a standalone covenant or merely an administrative requirement, as the consequences of non-compliance will differ accordingly.
There are myriad ways to bring about changes of control, and, as such, attention to change-of-control provisions often varies depending on the identity of the tenant in question. A tenant can take various forms, including an individual, a corporation, a general or limited partnership, a joint venture, a club, an association or even a combination of these entities. Therefore, when a lease prohibits the "change of control of the tenant" or the "change of effective voting control of the tenant", you must evaluate the identity of the tenant and the different types of control that exist.
Publicly traded corporations present a particular challenge in this context. Share ownership in a public company changes continuously through market trading, making it impractical for a landlord to monitor or regulate such changes. For this reason, leases with publicly traded tenants commonly include carve-outs exempting changes resulting from trading on a recognized stock exchange, while still capturing private placements or negotiated transactions that result in a new controlling shareholder.
What Does "Control" Mean?
It is not uncommon for the definition of control to be absent from a lease nor is it surprising given the complexity inherent in the concept. When the definition of control is absent from a lease, the parties must consider the primary types of control, namely i) de jure control and ii) de facto control and interpret the lease accordingly.
De Jure Control
The most common interpretation of control is de jure, or legal, control.
For corporations, legal control refers to the ability of a person or entity to elect a majority of the board of directors of a corporation. It is typically determined by examining the distribution of voting shares and any agreements that restrict or govern voting rights, such as shareholders' agreements.
For partnerships, determining control can only be properly understood by careful examination of the partnership agreement. Change of control in a partnership agreement is often articulated by reference to the partners themselves, with control generally meaning the possession of any person, directly or indirectly, of the [de facto] ability or influence to direct or cause the direction of the management or policies of another person, whether through ownership of voting securities or partnership or other ownership interests, by contract or otherwise. Control might be exercised on the basis of unit of partnership interest, a percentage interest in the partnership assets, by rules and requirements relating to the making of certain decisions (major decisions) and the delegation of authority to committees within the partnership.
A common issue in the partnership context is whether changes among limited partners (as opposed to general partners) should trigger a change of control. Given that limited partners typically do not participate in day-to-day management, parties should consider whether a change of control provision is intended to capture changes in limited partnership interests or only changes affecting the general partner.
When assessing who controls a trust and when control shifts, it is important to note that a trustee can take various forms, such as an individual, corporation, partnership or other legal entity. Therefore, the nature of the trustee and the governing documents must be carefully reviewed to evaluate control. In the context of real estate investment trusts (REITs), which are increasingly common as commercial tenants, the question of whether a change in unitholders constitutes a change of control requires particular attention. Publicly traded REITs present unique challenges, as unitholder composition changes continuously through market trading. For this reason, leases with REIT tenants often include specific carve-outs exempting changes in publicly traded units from change of control provisions, while still capturing changes in the trustee or manager of the REIT.
For a joint venture, determining control also requires careful examination of the joint venture documents. For other forms of joint ventures, such as co-ownerships, this may include examining the decision-making regime, the role of any investment or management committees and the restrictions of any change of control of the co-owners. Further, the nature of each co-owner must be analyzed to determine how changes in the control of a specific co-owner might impact the control of the joint venture under the co-ownership arrangement.
De Facto Control
Less commonly, leases attempt to capture de facto, or factual, control. This concept focuses on influence rather than legal authority as a party may exercise effective influence over an entity's strategic or operational decisions.
The Added Complexity of "Effective Control"
Many leases go further and prohibit changes in the "effective control" or "effective voting control" of the tenant. Effective control is commonly interpreted to mean indirect changes of control, such as a change in control of a parent or ultimate holding company of the tenant. The prohibition of a change in effective or effective voting control is often an attempt to prevent tenants from circumventing transfer restrictions by restructuring at a level above the tenant entity.
The lack of definition around the terms "control", "effective control" or "effective voting control" leads to uncertainty in interpretation and disputes amongst parties when a change of control arises. The courts provide little guidance on the interpretation of change of control provisions and what control means.
What Does the Case Law Tell Us?
The scarcity of recent appellate authority on change of control provisions in commercial leases underscores the importance of clear drafting as most disputes are likely resolved through negotiation or at the trial level without generating reported decisions. Although, the following two decisions provide useful guidance.
Delilah's Restaurant Ltd. v. 8-788 Holdings Ltd.
In Delilah's Restaurant Ltd. v. 8-788 Holdings Ltd., the British Columbia Court of Appeal considered a lease that deemed any change in the effective control of the tenant or its shareholders to be an assignment. The court held that a change in the number of shareholders from four to one during the relevant period (as well as the change of control between two of the parties—i.e., the different holding of shares) constituted a change of control that required landlord consent.
However, it is important to note that the court also held that since the landlord had continued to accept rent for several months after learning of the change of control, the landlord had waived its right to object to the change of control.
The decision highlights two important points. First, courts may give effect to broadly drafted change of control provisions. Second, landlords should act promptly and in a manner that is consistent with its position to avoid inadvertently waiving their rights.
Kiryat Development Inc. v. O'Brien's Restaurants Inc.1
In Kiryat Development Inc. v. O'Brien's Restaurants Inc., the Ontario Court of Appeal considered a clause requiring landlord consent for any share transfer resulting in a change in the effective voting control of the tenant. At the time the lease was executed, two families each held fifty percent of the shares of the tenant. When one family later acquired a majority interest, the court held that this constituted a change in effective voting control.
This case underscores the importance of defining the relevant baseline for control and clarifying whether changes are assessed by reference to internal relationships among shareholders or absolute voting thresholds. It is prudent to define terms so that there is no ambiguity regarding the interpretation or intent of the provision.
While these cases confirm that the interpretation of a change of control provision turns on the specific contractual language used, they nonetheless illustrate the importance of defining what constitutes a change of control with certainty to reduce ambiguity and the risk of capturing change of control conduct that was not intended.
From a remedies perspective, a landlord who discovers an unconsented change of control must also consider its practical options. Depending on the lease language, the landlord may have a right to terminate the lease, seek damages or pursue injunctive relief. However, the practical utility of these remedies varies significantly. Termination may be undesirable if the landlord wishes to retain a rent-paying tenant, and "undoing" a completed corporate transaction is rarely feasible. These enforcement realities further underscore the importance of clear drafting and, from the tenant's perspective, may support arguments for negotiating cure periods or notice-based regimes rather than strict consent requirements.
These cases discussed above solely concern the legal control of a tenant. However, in many instances, the primary point of contention in a change of control provision that restricts tenant transfers arises from changes further up the corporate chain, such as a change in the parent company or similar scenarios. As such, parties should consider the scope of a change of control provision in the initial negotiation stage.
Section 23 of the Commercial Tenancies Act
In Ontario, Section 23 of the Commercial Tenancies Act provides an important statutory overlay to contractual change of control provisions. The section states that any covenant, condition or agreement restricting the assignment, subletting or transfer of possession of land or property is subject to the implied condition that the landlord's consent shall not be unreasonably withheld, unless the lease contains an express provision to the contrary.
The application of Section 23 to change of control provisions is not entirely settled. While the section expressly refers to "assignment, subletting or transfer of possession", a question arises as to whether a change of control, which does not involve a transfer of the lease itself, falls within its scope. If a change of control is deemed a "transfer" under the lease, the statutory reasonableness requirement may apply unless expressly excluded. Landlords who wish to retain an absolute right to withhold consent to a change of control should therefore include explicit language in the lease stating that consent may be withheld in the landlord's sole and absolute discretion.
Negotiating the Scope of Change of Control Provisions
While the scope of a change of control provision depends largely on bargaining power of the tenant and the tenant's future restructuring plans, certain themes recur in negotiation. From the landlord's perspective, the definition of a change of control provision should be broadly constructed in order to capture any change of control up the corporate chain, whether it be legal, factual or effective. Landlords frequently take the position that a change of control should be regulated in the same manner as a transfer of the lease.
However, from the tenant's perspective, the definition of a change of control, if requiring consent at all, should be narrowly construed, allowing the tenant to deal with its organization without triggering landlord consent. In the event a landlord insists on a broadly drafted change of control provision, tenants should consider carve-outs for transactions that do not materially alter the risk profile of the tenancy, including:
- A change of control involving a holding corporation, subsidiary or an affiliated or related entity, sometimes limited to wholly owned subsidiaries.
- A change of control resulting from a merger or amalgamation.
- A change of control involving entities owned or controlled by existing shareholders or their family members.
- Changes among existing shareholders, frequently limited to those in place at the time the lease is executed.
- Transfers by bequest or inheritance, which are outside the tenant's control.
- A change of control of a publicly traded tenant resulting from trading on a recognized stock exchange.
- Landlords may be willing to accommodate some of these exceptions, but typically on the basis that consent is still required, albeit not to be unreasonably withheld, rather than granting an unfettered right to change control.
Key Takeaways for Practitioners
Given the above, several practical lessons emerge from the limited jurisprudence and general lack of clarity:
- Define change of control terms with precision. Terms such as "control", "change of control" and "effective voting control" should be clearly defined.
- Align the clause with commercial intent. If the goal is to capture indirect transfers through parent entities, the lease should be explicit.
- Treat change of control consistently with assignment provisions. Where appropriate, applying the same consent standard can reduce uncertainty. Alternatively, a lease should clearly state whether a change of control, however defined, is considered a transfer under the lease and subject to the transfer restrictions.
- If a landlord is concerned about maintaining continuity in the entity or individual that ultimately controls the tenant, they should include
- explicit language in the lease specifying that a change in control of a direct or parent entity will be considered a change of control of the tenant.
- Beware of waiver. Landlords should be advised to act promptly upon learning of a potential breach and to avoid conduct that could be construed as acquiescence.
- Account for bargaining power. The final form of the clause will often reflect the relative leverage of the parties; however, clarity of such terms benefits both parties.
- Given the discussion above regarding Section 23 of the Commercial Tenancies Act, landlords who wish to retain an absolute right to withhold consent should ensure the lease contains express language to that effect.
Conclusion
Change of control provisions remain an underdeveloped area of Canadian commercial leasing law. In the absence of extensive judicial guidance, clear and careful drafting remains the primary tool for managing risk for both landlords and tenants. By clearly defining key concepts and aligning lease language with the parties' commercial objectives, landlords and tenants can significantly reduce the risk of future disputes and unintended consequences.
For more information about the issues discussed in this blog, please contact the authors or a member of the Bennett Jones Property Development & Real Estate group.
1 Kiryat Development Inc. v. O'Brien's Restaurants Inc, 1987 CarswellOnt 3045, 6 A.C.W.S. (3d) 35 (Ont. Dist. Ct.) [Kiryat].
