Failure to close: Speculative profits, sunk costs

Read the full article on The Lawyer’s Daily here.

“The basic speculative impulse, which is to believe whatever best serves the good fortune you are experiencing.”John Kenneth Galbraith 

Let’s say you were about to buy seven apartment buildings for roughly $228 million. On the closing date, you are ready to go. But, through no fault of your own, the seller decides not to close. The real estate market is rising, and the seller believes it is better to speculate on the market and wait a couple of years before ultimately completing a sale.

Eventually, they sell the properties for $56 million more than the original purchase price to another party. As the buyer, should you be entitled to receive this speculative profit as damages through litigation, since you have been deprived of the good fortune you could be experiencing?

This was the situation occurring in Akelius Canada Ltd. v. 2436196 Ontario Inc. 2022 ONCA 259. Prior to closing in 2016, the buyer requisitioned that certain mortgages be removed from title. The balance owing on the mortgages was about $48 million, but the seller was unable or unwilling to remove the mortgages. The seller proposed that the buyer either assume the mortgages with a corresponding price abatement, or that the specific properties subject to the mortgages be removed from the sale transaction.

However, as the buyer was an international company in the apartment investment and rental business, they rejected these offers. Instead, they had plans to renovate and improve the seven residential apartment buildings together, particularly because all the properties were conveniently located near one another in downtown Toronto. If the existing mortgages on title were assumed, it would interfere with the new financing they intended to obtain to make those renovative changes. Even with a price reduction, everything would have been made impermissibly more expensive.

The seller thus ended up breaching the Agreement of Purchase and Sale (APS), held on to the properties until 2018, and ultimately sold the properties for a $56-million profit. Even though the buyer was not in the business of flipping properties for quick profits, they brought a lawsuit for the lost capital gains only and not for the lost rental investment income.

One of the first things the motion judge did was agree with the buyer’s request for its sunk costs of $775,855.46 from the aborted real estate transaction. The buyer incurred significant legal and professional fees in the course of negotiating, drafting and executing the APS. Further fees were incurred in identifying the impugned mortgages, holding the seller to their obligation to remove them from title and taking steps to tender when the buyer was ready, willing and able to close.

The Court of Appeal agreed with this assessment on sunk costs, and went on to provide further clarification with respect to the motion judge’s analysis of the lost speculative profits of $56 million.

In such cases, the starting point of the damages analysis is determining the date of breach of the APS. Usually, this is the closing date, but courts may choose a different date depending on the context. The basic principle is that the award of damages should put the injured party in nearly the same position it would have been in had the contract been performed.

While the date of breach would have been in 2016 when the transaction failed to close, the buyer asserted the date for damages assessment should be in 2018 when the properties were sold for the large profit. It argued that it should have been given time to attempt to purchase a comparable portfolio of properties in Toronto’s rising real estate market.

The buyer based this argument on a line of cases supporting the proposition that the damages assessment date can be moved somewhat later, in cases where the plaintiff has established it was not in a position to re-enter the market at the time of breach. For instance, in Domowicz et al. v. Orsa Investments Limited [1994] O.J. No. 2489, the plaintiff buyer was successful in recouping $700,000 of speculative profit and the damages assessment date was determined as being three months later than the date of breach.

The Court of Appeal disagreed with the buyer’s interpretation of this case. In Domowicz, the apartment building buyer had originally claimed the damages assessment date as being three years later than the date of breach (which conveniently coincided with an approximate peak of the Toronto real estate market), but it was determined that such a length of time was not needed to find a suitable replacement property.

Moreover, in Domowicz, the plaintiff buyer provided detailed evidence of its lost revenue damages. In Akelius Canada Ltd., similar evidence had not been filed of what the buyer would have made in capital appreciation had it sold the properties in 2018 when the seller did. Even if it could have shown that it could not have bought other similar properties that appreciated as much in the same time period, the buyer did not establish why it could not re-enter the market for over two years or why it was necessary to purchase all the properties together for the purposes of capital speculation.

It was also noted that the seller may have breached the APS for the purposes of achieving its own speculative profit, and not to deprive the buyer of its potential capital gain. In particular, the buyer was involved with income-generating rental properties; its business model was well known; and it would not likely be selling the properties in the near future anyway. Since the buyer was instead a long-term investor, the capital appreciation would not have been relevant to the reasonable contemplation of the parties at the time when the APS was signed.

While the “basic speculative impulse” is to try to capitalize on good fortune wherever you may be able to find it, you will have to make the court believe that the date your loss crystallizes is sufficiently connected to the date of breach and the objectively understood purpose of the contract.


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