SCC Rules on Mitigation and Specific Performance in a Real Estate Deal Gone Wrong

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[author: Derek J. Bell]

And the bravest man in all the land
Turns white with mortal fear.
For he knows the smallest leak may grow
To a flood in a single night;
And he knows the strength of the cruel sea
When loosed in its angry might.

P. Cary, "The Leak in the Dike" (1873)

The concept of mitigation, in essence, is that a plaintiff cannot sit idly by, watching damages escalate if reasonable steps can be taken to avoid or reduce the loss. Having seen the leak in the dike, the theory would hold, the Dutch boy is obligated in law to stop the flood by stopping the leak, rather than waiting for the dike to break altogether, with the catastrophic losses (the "strength of the cruel sea") that would ensue. In a real estate context, mitigation means purchasing a reasonable alternative property.

A tricky mitigation question arises, however, when a plaintiff is seeking specific performance. Specific performance is a remedy that is sometimes pleaded in the alternative to damages: the plaintiff says that the defendant breached a contract, and specific performance would require the defendant to perform the contract. Damages would be sought in the alternative. This type of relief is not at all uncommon in lawsuits involving real property: the transaction fails to close, the plaintiff sues to have the property delivered. The next natural question is: If plaintiffs sue for specific performance, do they still have to mitigate?

On the one hand, the duty to mitigate completely runs counter to the concept of specific performance. If I sue to have my property returned, it makes no sense to have me mitigate by purchasing another property.

On the other hand, from the defence perspective, why shouldn't the plaintiff have to mitigate, particularly if they lose their case for specific performance? If you slightly change the fact situation, you can see where the real problem arises. Assume that a plaintiff sues for recovery of real property worth $100,000. The plaintiff loses the claim for specific performance, because the judge finds there was nothing unique about the property, and damages would therefore be an adequate remedy. But while the lawsuit was ongoing, that property increased in value from $100,000 to $1 million. Does the defendant have to pay the $1 million, when the plaintiff could have bought replacement property that would also have increased in value? Shouldn't the defendant's damages be capped at $100,000?

In a decision released October 17, 2012, the Supreme Court of Canada answered this question with an unequivocal "sort of". In Southcott Estates Inc. v. Toronto Catholic District School Board, the plaintiff, Southcott, sued the Toronto Catholic District School Board for specific performance when the Board failed to satisfy a condition in an agreement of purchase and sale, and failed to extend the closing date.

The trial judge and the Court of Appeal found that the Board had breached the contract. But both the trial judge and the Court of Appeal found that Southcott was not entitled to specific performance, because there was nothing unique about the property, and damages were an adequate remedy. The question then became: what was the quantum of damages? And in particular, should such damages be reduced because of a failure to mitigate?

Southcott argued that, although it lost the claim for specific performance, it was still reasonable to advance the claim, because it proceeded expeditiously and there was substance to the specific performance claim. Even though it did not succeed, it was still reasonable for Southcott to not mitigate its damages by purchasing alternative property.

The Supreme Court of Canada agreed that "there may be situations in which a plaintiff’s inaction is justifiable notwithstanding its failure to obtain an order for specific performance where circumstances reveal 'some fair, real, and substantial justification' for his claim or 'a substantial and legitimate interest' in seeking specific performance".

The Supreme Court continued, that substantial justification does not completely relieve the plaintiff with an obligation to mitigate, "rather it recognizes that such a claim for specific performance informs what is reasonable behaviour for the plaintiff in mitigation".

But in this case, the Supreme Court found that Southcott did not have substantial justification. Why? Because "[a] plaintiff deprived of an investment property does not have a “fair, real, and substantial justification” or a “substantial and legitimate” interest in specific performance unless he can show that money is not a complete remedy because the land has “a peculiar and special value” to him.

And because the trial judge found that specific performance was not available, as "the land was nothing more unique to Southcott than a singularly good investment", the Court concluded that "Southcott cannot therefore justify its inaction."

The Court therefore concluded that Southcott still owed a duty to mitigate its damages, notwithstanding its specific performance claim, and Southcott failed to mitigate its damages by purchasing reasonable alternative properties.

The Effect of the Decision

The Supreme Court did not expressly make new law in Southcott. Prior decisions of the Court (in 1979 and 1996) already recognized the duty to mitigate and what one needs to show to establish that a property is unique.

But the real effect of this decision is to make claims for specific performance substantially less attractive to plaintiffs, particularly in real estate transactions. In most cases, such plaintiffs will still have a duty to mitigate, which could involve purchasing alternative properties that are on the market. Therefore if a plaintiff really wants to maintain the claim for specific performance, the plaintiff may need to go "all in", meaning that if they lose that claim for specific performance, and they fail to mitigate, they may obtain something less than the actual damages they suffer at the time of the judgment.

And indeed, if the plaintiff does purchase alternative property to mitigate, it is difficult to see how such a plaintiff could ever succeed in a claim for specific performance. When the plaintiff claims at trial the property was unique and therefore the court should grant specific performance, the defendant would naturally respond, "How can they say that? Look at this replacement property they purchased; of course the property was not unique."

Assuming the plaintiff can get past that hurdle, and actually succeeds in establishing specific performance after purchasing replacement property, what does the plaintiff do now? It now has two properties. While the plaintiff could just later sell the property that was purchased to mitigate, what if there was an illiquid market for the property (such as after a real estate crash, or for shares in a company that are thinly traded)?

Critics of the Supreme Court's decision in Southcott could argue that this decision results in unjustifiable windfalls to the defendants. Using the analogy of the $100,000 property that increases in value to $1 million, if the Court awards damages, then that means that the defendant was in breach of its legal obligations. Notwithstanding the fact that the defendant was breaching its legal obligations, that same defendant would enjoy the $900,000 increase in value, because the plaintiff should have purchased replacement property in the interim. And it is no matter that the plaintiff sought specific performance (and it appears it does not even matter if the plaintiff had a good case for specific performance) to have the property delivered. The benefit still accrues to the defendant.

But such battles were lost almost 40 years ago in the Asamera case. In that case and others, the courts have basically viewed this result as an allocation of risk exercise. If the plaintiff can take reasonable steps to replace the property, then upon doing so, the plaintiff would enjoy the rise in fortunes related to that property, and similarly suffer the consequences of a decline in value. But if the plaintiff does not take those reasonable steps, then the plaintiff has effectively walked away from the benefits (or burdens) of ownership in the intervening time, and in so doing, those rights are effectively transferred to the defendant.

The net result? If you seek specific performance and choose not to mitigate your losses in the interim, you do so at your own peril. Of course, what constitutes reasonable steps to mitigate will vary from case to case and as such there may be other reasons to not take intervening steps prior to trial. No doubt plaintiffs will rely on the Court's comment in Southcott that "such a claim for specific performance informs what is reasonable behaviour for the plaintiff in mitigation" to allege that the very good (but ultimately unsuccessful) claim for specific performance, coupled with other factors, leads to the result that purchasing replacement property (or other steps to mitigate) was not reasonable.

While each case will turn on its specific facts, one potential way of avoiding the consequences of Southcott, at least as it relates to real property, is to seek a lis pendens or "certificate of pending litigation" at an early stage with respect to the property. This effectively registers a notice on the property, such that if it is ever sold, the purchaser has notice that someone is seeking to recover the property. Before a court makes an order for lis pendens, it will engage in an analysis of whether the property is unique. If the Court decides at that early stage that the property is not unique, it will not issue a lis pendens, and presumably at that point the plaintiff would know that it has to mitigate its losses by purchasing replacement property. And if the Court decides that the property is unique at that early stage, then that should go a long way, if not the entire way, in establishing a "substantial and legitimate interest" in the claim for specific performance.