BANKRUPTCY AND COMMERCIAL TENANCIES: LANDLORD’S RIGHTS

As the COVID-19 pandemic endures and a possible second lockdown looms, a consequence that will likely follow is a recession that will bring about a wave of bankruptcies of small and medium size businesses. Although the federal and provincial governments have rolled out the Canada Emergency Commercial Rent Assistance (“CECRA”) to provide businesses commercial rent relief, many have criticized this assistance and other efforts as falling fall short of what is required to save these businesses from bankruptcy.

So what should commercial landlords be concerned about as these economic consequences unfold? Commercial landlords will need to be aware of their rights in case a commercial tenant enters bankruptcy. This article aims to offer some insight into what a landlord can expect in such a situation.

DISTRAINT RIGHTS AGAINST A BANKRUPT TENANT

Landlords have rights to seize and sell assets owned by a tenant located on the leased premises to satisfy any rent in arrears or claims of damages to the leased premises. However, under section 136(1)(f) of the Bankruptcy and Insolvency Act (“BIA”), distraint rights are converted into a preferred claim on bankruptcy for up to three months of arrears and three months of accelerated rent (if the lease contains an acceleration clause). Landlords can therefore attempt to collect these amounts up to the realizable value of the assets on the premises.

Amongst the parties a landlord’s preferred claim is subordinate to are:

• Secured creditors;
• Unpaid workers for wages, salaries, commissions, compensation or disbursement;
• Fees owed to the Superintendent of Bankruptcy or costs incurred by anyone acting at the direction of the Superintendent; and
• A section 427 Bank Act security.

The rights of these parties are not absolute against the landlord’s distraint rights. For example, secured creditors can only assert a claim up to the value of security. Any remaining equity in the secured property belonging to a tenant may be distrained by the landlord. If secured property is subject to a conditional sales agreement, which reserves title to the supplier, a landlord may not distrain this property. However, a landlord could pay any remaining payments under the agreement and assume the tenant’s equity in this property.

Landlords should be aware that a creditor can displace a landlord’s distraint rights by seeking a stay of distraint rights if the tenant is under court-ordered receivership. A creditor can also bring an application for bankruptcy against the tenant under which the creditor can seek to terminate a landlord’s distraint rights. Landlords should also be aware that if they terminate the lease, they have no right to distraint.

In the case of a s.427 Bank Act security, which transfers title in property to a bank or other institutional lender, the security only takes priority over a landlord’s distraint rights if the security attached to the property before rent arrears arose. If this security attached after arrears arose, the landlord’s distraint rights have priority.

Timing is important to distraint rights in other ways. For example, if a landlord distrains property and sells it before the tenant is in bankruptcy, the landlord may keep the proceeds. However, if the landlord does not exercise their distraint rights by the time the tenant is in bankruptcy, by either not selling distrained property or by virtue of not having received the proceeds yet, the property or proceeds must be handed over to the trustee-in-bankruptcy or a secured creditor with priority minus the landlord’s cost of seizure as per s.73(4) of the BIA.

OCCUPATION RIGHTS OF TRUSTEE-IN-BANKRUPTCY

Section 38(2) of the Commercial Tenancies Act (“CTA”) allows a trustee-in-bankruptcy to occupy premises leased by a bankrupt tenant for up to three months, even if the tenant is in arrears, to take inventory and liquidate assets. During occupation, a trustee must pay occupation rent, which is the equivalent of the monthly rent payable under the lease. After three months of occupation, a trustee must elect to either retain or disclaim the lease (ss.38-39, CTA).

If the trustee disclaims the lease, then a landlord can claim preferred creditor status as discussed previously. Any accelerated rent payments (if there is an acceleration clause in the lease) made by a trustee are credited against the amount payable by the trustee for occupation rent.

Once a trustee disclaims the lease, a landlord can no longer claim rent for the remainder of the lease term as, once disclaimed, all rights and obligations under the lease become terminated. If the trustee retains the lease, they must pay any outstanding arrears.

ASSIGNMENT RIGHTS OF TRUSTEE-IN-BANKRUPTCY

A trustee can also assign the lease for value. Generally, a trustee must obtain the landlord’s consent to do so. However, if a landlord refuses to provide their consent, the trustee can seek a court order to assign the lease if the proposed assignee agrees to fulfill the terms and obligations under the lease. Landlords should be aware that the trustee’s right to assign the lease supersedes the landlord’s right to terminate it. Under s.38(2) of the CTA, a trustee can assign the lease even if the lease itself prohibits assignment without the landlord’s consent. Before they can bring an application to court to force assignment of the lease without the landlord’s consent, a trustee must pay all arrears.

THE LAWYERS AT CHAND & CO. CAN HELP COMMERCIAL LANDLORDS

The lawyers at Chand & Co. can assist landlords in drafting lease agreements that anticipate the issues outlined in this article in order to preserve their distraint rights as fully as possible. Our lawyers can also assist and guide landlords through the legal processes outlined above should they be initiated and affect a commercial property or lease.

Often times, there is opportunity to negotiate arrangements with creditors to ensure that the landlord is able to obtain some relief for unpaid rent without recourse by either party to the courts. Other times, a landlord will require an expert litigator, like those at Chand & Co., to resist efforts by creditors to displace or terminate their distraint rights. Whether negotiations or litigation is anticipated, landlords can trust our firm to understand their needs and protect and further their rights.