Landlords may end up with unwanted tenants and unpaid rent as a result of recent changes to Canada’s bankruptcy and insolvency laws.
The changes, which flew under the radar of many real estate lawyers, unnoticed even by some experts in property law, were part of a package of amendments to the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act enacted in September 2009. The wording leaves room for interpretation and they have yet to be tested in court, but the amendments appear to have given bankruptcy trustees the right to assign leases if a tenant goes bankrupt — a departure from existing case law that could have significant implications, particularly for shopping mall owners.
“The long and the short of it is that it is expected that landlords are not going to be faring so well,” says Joseph Grignano, a partner in the real estate group at Blake Cassels & Graydon LLP.
Before the federal government enacted the amendments, courts would consider the provisions of provincial tenancy laws in determining whether and how leases could be assigned to new tenants when an existing tenant declares bankruptcy. While the legislation and case law differed from province to province, landlords had some level of comfort that the terms of their leases would not be drastically altered and they would not be saddled with an unsuitable tenant.
In Ontario, prior to the amendments, the courts wouldn’t change the use that the property was being put to, says Grignano. So, for example, if a shoe store went bankrupt, the lease would not be assigned to a dollar store. But the amendments give the courts much broader powers. The interests of landlords may be offset by concerns for other creditors and for the greater good. A tenant might argue that hundreds of jobs would be saved by assigning the lease in a certain way and the courts could take that into account.
Landlords are concerned that they will be stuck with a new tenant or a use that they don’t really want, says Grignano, who notes this is a major issue for shopping mall owners. “These are highly controlled environments and this is moving control out of the landlord’s hands into the court’s hands and landlords believe they’re in a better position to know how to run their malls than the courts,” he says.
A further concern is that the amendments will limit landlords’ ability to recover arrears in rent or accelerated rent (to cover the tenant’s lease obligations for three months following the bankruptcy). This concern arises from the peculiar wording of the amendments. On the one hand, the BIA and CCAA amendments stipulate that a court may not assign a lease unless it is satisfied that all monetary defaults will be remedied on or before a date fixed by the court. But the amendments also state that these monetary defaults do not include those that arise from the person’s bankruptcy or insolvency — a proposition that leaves some lawyers wondering how to argue that a bankrupt tenant’s rent default was not a result of his or her insolvency.
Landlords in Nova Scotia have similar concerns, according to Michael Kennedy, a partner practising commercial real estate at the Halifax firm Wickwire Holm, and Pamela Clarke, a partner in the same firm specializing in insolvency law. “Landlords will likely see this as an invasion of the rights of landlords with respect to the termination of the use and the suitability of the tenants occupying their premises,” they wrote in an e-mail to Canadian Lawyer.
The two lawyers note the amendment to the BIA does not clearly identify that there are any protections for landlords with respect to the use of premises by the assignee of the trustee. Not only does the amendment provide that landlords are not entitled to collect any arrears arising from the previous tenant’s insolvency, but it also seems that funds paid by the new assignee as consideration for the assignment would be available to all preferred creditors, rather than going directly to the landlord, the Wickwire Holm partners observed.
Harvey Haber, a senior partner at Goldman Sloan Nash & Haber LLP in Toronto and author of several Canada Law Book publications on commercial leasing, says he’s puzzled by some of the wording of the amendments, particularly a clause stating the provision regarding the assignment of leases “does not apply in respect of rights and obligations that are not assignable by reason of their nature.”
“Nobody understands that,” says Haber, observing that this wording raises a question as to whether or not the provision applies to property leases at all. He and other lawyers agree this is an open question since the amendments have yet to be tested in the courts. However, the prevailing wisdom among lawyers who have delved into this issue is that the amendments do apply to property leases and, as Haber suggests, caution dictates that one should assume this to be the case until the courts rule otherwise.
Grignano says there is also a question as to whether or not the legislation is constitutional, since it involves the federal government legislating in an area that was previously dealt with by the provinces. In fact, his firm’s research indicates that previous attempts by the federal government to include similar provisions in the BIA were struck down by the courts in 1929. “If a big enough insolvency comes up, landlords might band together and challenge this,” says Grignano.
The amendments also address situations where it is the landlord, rather than the tenant, who goes bankrupt. But these changes are largely uncontroversial, according to Derek McCallum, a partner and member of the real estate and distressed real estate asset groups at Aird & Berlis LLP. He says the amendments to the BIA and CCAA essentially codify existing case law, stating that the bankruptcy of a landlord doesn’t give a receiver or trustee any power greater than a landlord to terminate a tenant’s lease.
McCallum says Canada’s insolvency legislation is very different from U.S. laws in this regard, since U.S. bankruptcy trustees are allowed to sell properties free and clear of leases, “and if you’re a tenant, you’re out of luck.”
Of greater concern to tenants in Canada, when their landlord goes bankrupt, is what will happen after a new landlord acquires the property, says McCallum. For this reason, tenants are always advised to ensure that subsequent purchasers have notice of lease agreements. They should also get non-disturbance agreements from the landlord’s lenders and get notice of the lease registered on title, he says.
And what can landlords do to protect themselves against a tenant going bankrupt? In light of the insolvency law amendments, says Grignano, “There’s unfortunately not much you can do.”
Grignano’s only suggestion — and one he admits is of questionable value — is to put more restrictions in the lease on the types of use that are not permitted. This might help with a few more arguments in court and establish a few roadblocks in the event that the trustee assigns the lease to an unsuitable tenant, but ultimately the new legislation will likely override the landlord’s challenge, he says.
Litigator Brendan Bissell, an associate at Goldman Sloan, agrees. If the lease contains exclusive enough language, a landlord’s lawyer could argue the lease is not something that is assignable by its nature, he says. However, he adds, this is an argument that could best be leveraged in out-of-court negotiations. “I don’t think, if push came to shove, you would have a very good chance of winning on a judicial determination.”
Freelance journalist and business writer Kevin Marron can be reached at email@example.com.