Friday 16 August 2013

Zoning Error No Bar to Sale of Business

    The purchaser learned the business
    wasn't zoned for a dry cleaning facility
Chang Lee agreed to buy a Toronto dry cleaning business.  Although the business had been in operation for more than 15 years, neither the purchaser nor the vendor knew that the City had changed the zoning two years before the date of sale, and that the location was no longer zoned for the operation of an on-site dry cleaning facility.  Could Mr. Lee get out of the deal? The Ontario Court of Appeal said no.
The decision contains a concise summary of the law on mistake in contracts, covering mutual mistake, common mistake, and equitable mistake.  This area of law can be confusing.  It often seems that the rule is that a mistake doesn't get you out of a contract, except when it does.  This well-reasoned decision of the Court of Appeal shows how the policy basis for the law should determine the application of the doctrine in specific situations.
The Zoning Change
The parties negotiated an agreement of purchase and sale through a real estate broker using a standard form provided by the Ontario Real Estate Association.  Mr. Lee was to buy all the assets of the business, including the lease, goodwill, and trade name, for $340,000.  Neither Vendor nor Purchaser consulted a lawyer until after the agreement had been signed.
The contract contained an "entire agreement" clause stating that there were no representations, warranties, or conditions other than those expressed in the agreement itself.  The only reference to zoning was a clause stating that the parties weren't relying on the broker for information on zoning, and that they had been told to seek professional advice.
The business had been operated as a dry cleaning plant continuously since 1995.  The Vendor acquired it in 2005, and had obtained a license every year from the City authorizing the operation of a dry cleaning business.  Apparently the business license was renewed at least once after the change in zoning.  Although the City had given notice of the change as required by statute, the Vendor was unaware of the change and the topic of zoning never came up during the negotiations.
Summary Judgment
The case was decided on a summary judgment motion.  The motion judge considered mutual mistake, where each party is mistaken about a different matter and there is no contractual consensus, as well as the doctrine of common mistake, where the parties share an erroneous assumption about a fundamental fact.  She concluded that there was a common mistake that "the property was properly zoned, such that the dry-cleaning business was a permitted use."
The motion judge also concluded that Mr. Lee was entitled to relief on equitable grounds.  Although equitable mistake seems to have been abandoned by courts in England after the 2003 decision of the Court of Appeal in Great Peace Shipping v. Tsavliris Salvage, [2003] Q.B. 679, this decision has not yet been adopted in Canada.  In equity, a contract can be set aside where the parties are under a common misapprehension as to a fundamental fact and the party seeking to avoid the contract is not at fault.  The motion judge found that the Vendor would be unjustly enriched if the deal went through, as the purchase price was based on a shared belief that the location was properly zoned.
The Court of Appeal Decision
The decision of the Court of Appeal was delivered by Strathy, J.A.  He concluded that the motion judge had made three errors:
(1)   She made a palpable and overriding error in the assessment of the evidence when she found that the parties both assumed that dry cleaning was a "permitted use";
(2)   She erred in law by putting the onus on the Vendor to show that the business could continue to operate as a dry cleaners, when the onus should have been on the Purchaser to show that it could not;
(3)   She erred in law by putting the risk of mistake on the Vendor, when under the principle of caveat emptor it should have been on the Purchaser.
The decision turns on a principle in zoning law called the doctrine of "legal non-conforming use".  A change in zoning law does not prevent a property from being used for a particular purpose where that use was legal at the time of the change, so long as the property continues to be used for that purpose.
Although dry cleaning was no longer a "permitted use" after the change in zoning, it was likely still a "lawful use" in that the Purchaser would be able to continue that use as a legal non-conforming use.  The parties shared a lay person's understanding that the Purchaser would be able to operate the business as it had been operated by the Vendor.  If the Purchaser had a more technical understanding of the difference between a permitted use and a use that could be lawfully continued, his mistake was unilateral.  If he shared the Vendor's belief that the use could be continued, this was not a mistake unless it could be shown that the business could no longer operate as a dry cleaner.  This is where the onus of proof becomes an issue.
In response to an inquiry from the Purchaser's lawyer just before closing, the City had advised that dry cleaning was not a permitted use, but took a neutral stand on whether it constituted a legal non-conforming use.  No-one had applied to the City for that determination.  The motion judge said there was no evidence that the City would allow the current use to continue.  In doing so, she put the onus on the Vendor to show that the use would be allowed by the authorities.  Since the Purchaser was a Plaintiff seeking to rescind the contract, the onus was actually on the Purchaser to demonstrate that the use could not be continued.  In the absence of any evidence, the Purchaser had failed to establish this part of his case.
Strathy, J.A. also pointed out that the law of mistake could not be used to transfer contractual risk from one party to another.  The Purchaser had not insisted on making the contract conditional on zoning, although there were other conditions in the contract and zoning conditions are often inserted in such agreements.  The contract contained an acknowledgement that the parties had been urged to obtain independent advice on zoning.  By signing the agreement without any zoning conditions, and by failing to obtain independent confirmation of the zoning, the Purchaser had assumed this risk.
Placing the risk of zoning problems on the Purchaser is also consistent with the principle of caveat emptor, under which the buyer is expected to inquire into risks associated with the transaction.
For the same reasons, equitable mistake could not assist the Purchaser.  Relief in equity is only available where the Plaintiff is not at fault.  Mr. Lee was at fault in that he had failed to take reasonable measures to protect himself, either by investigating the zoning or by negotiating a warranty with respect to the use.
The law of mistake in contracts seeks to reconcile two competing values.  On the one hand, the economy will function better if business people can be sure that contracts will be enforced as written.  Thus the law favours certainty.  On the other hand, fairness seems to require that a contract should be set aside where the parties' agreement is based on a set of facts that turn out to be untrue.
The decision of Strathy, J.A. illustrates how the courts balance the values of certainty and fairness by putting limits on the scope of the doctrine of contractual mistake.  The mistake must be mutual.  It must involve facts that are fundamental to the contract.  The onus is on the Plaintiff to show that there was a mistake.  The doctrine of mistake cannot be used to reallocate a risk that one party assumed in the contract itself, or to reverse the rule of "let the buyer beware".  Mistake does not assist someone who failed to conduct an investigation before signing the contract, or to insert standard provisions into the contract that would have protected his interests.
It is unclear why the parties to this case did not seek a ruling that the continued operation of a dry cleaning facility was a legal non-conforming use; this could have saved a lot of time and legal costs.
Query: shouldn't a standard form agreement for the purchase of a business contain a provision dealing with zoning? A clause stating that the Vendor warrants that the current use can be continued could be deleted in transactions where it doesn't apply.

Lee v. 1435375 Ontario Ltd., 2013 ONCA 516
 Contact Richard Hayles at Billington Barristers:
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Any legal information provided is general in nature and may not apply to particular situations. It does not constitute legal opinion or advice. Please consult your lawyer regarding your specific legal issue.

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