Even in positive economic times, a commercial landlord may be faced with the bankruptcy of a tenant. When this happens, the Landlord appears to suffer twice. First, rental payments cease. To add insult to injury, the Landlord runs head-on into the sometimes complicated area of bankruptcy law. For example, you might think that upon being faced with a bankruptcy, a Landlord could simply find a new tenant. That is not the case. While a Landlord might be able to terminate a lease prior to a bankruptcy, many of the usual remedies to deal with a defaulting tenant are lost when a bankruptcy occurs. Read on for a short primer concerning a Landlord’s position when a tenant goes bankrupt.

A tenant’s bankruptcy involves both federal legislation, the Bankruptcy and Insolvency Act, and provincial legislation, the Commercial Tenancy Act. Under the Bankruptcy and Insolvency Act, a stay of proceedings is automatically imposed to prevent creditors from taking any action against an insolvent person once a bankruptcy has occurred. As a result, no creditor, including a Landlord, has a remedy against the insolvent person or their property. This means that a commercial Landlord’s usual remedies such as distraint, termination of the Lease, re-entry of the premises, or the commencement of a court action, are lost. What’s worse, the Landlord may be forced to stand by while the bankruptcy trustee determines what is to happen with the leased premises.

Under the Commercial Tenancy Act, the trustee has the right to occupy the leased premises where the lease does not create a monthly tenancy or has not been terminated prior to the date of the bankruptcy. Generally speaking, the trustee receives the benefit of the tenant’s lease and is entitled to retain this benefit for up to three months. During this "look-see" period, the trustee has three options with respect to the bankrupt tenant’s leased premises. These are:

1. the trustee can occupy the premises for up to three months;
2. the trustee can sell or assign the lease interest by obtaining the approval of the Court; and
3. the trustee can simply disclaim or surrender the lease.

The trustee may choose any of these options regardless of whether the lease terms prohibit them. That said, a Landlord should keep in mind that the trustee is obligated to pay occupation rent for the time in which it actually occupies the leased premises less, of course, any rent paid in advance by the former tenant and any monies paid as accelerated rent.

Unfortunately for a Landlord, it will have little say in the type of tenant to which the trustee may assign the lease. The only safeguard here is the requirement for the trustee to obtain the Court’s approval as to the assignment to the replacement tenant. The Courts have held that when an application to approve an assignment is made by a trustee, the Court must satisfy itself that the new tenant will be responsible and respectable, personally and financially. The onus is on the trustee to prove that this is the case.

As a small measure of comfort, a Landlord can insist that any replacement tenant proposed by a trustee must obey the terms of the lease in question. For example, a restrictive covenant in the lease would apply to the replacement tenant in the same fashion as it did to the former tenant.

There are some small silver linings in the bankruptcy cloud for the Landlord. First, the Bankruptcy and Insolvency Act provides that a Landlord is granted a preferred claim for:

1. arrears of rent for three months prior to the bankruptcy; and
2. accelerated rent for a period not exceeding three months after the date of the bankruptcy if this claim is authorized under the lease.

Landlords should ensure that their lease forms provide for a claim of accelerated rent in the face of a bankruptcy. The arrears of rent which may be claimed are calculated for a three-month period ending on the day immediately prior to the bankruptcy while occupation rent runs from the date of the bankruptcy. There is one catch in order for the Landlord to obtain any amounts for accelerated rent – the bankrupt must have property on the leased premises upon which the trustee can realize. The Bankruptcy and Insolvency Act restricts the Landlord’s preferred claim to the amount which can be realized from the bankrupt’s property on the premises. A Landlord continues to rank as an unsecured creditor for the balance of accelerated rent not payable on a preferred basis up to, of course, the three-month limit.

The Courts have also recently held that a Landlord may take action against a guarantor under the lease even when a tenant has gone bankrupt (Crystalline Investment v. Domgroup Ltd. [2004] S.C.J. No. 3). In this case, the Supreme Court of Canada took the opportunity to construe the Bankruptcy and Insolvency Act narrowly by deciding that the termination of a lease in a bankruptcy would relieve only the bankrupt tenant from its obligations to the Landlord. Guarantors or assignors of the lease remained liable.

A Landlord may also encounter a tenant’s proposal under the Bankruptcy and Insolvency Act rather than a bankruptcy itself. A proposal is an effort on the part of the tenant to avoid bankruptcy by presenting a plan to its creditors, including the Landlord, to permit the tenant to get "back on its feet". The tenant’s creditors vote on the proposal which must pass according to a formula set out in the Act. The tenant will become bankrupt if the proposal is not approved.

In general, a Landlord will be required to permit a tenant to remain in the leased premises while the proposal process is taking place. This is the case even when there are arrears although rent is to be paid while the occupation continues. A Landlord can seek permission from the Court to terminate the lease if ongoing rent is not paid.

There is no set way in which Landlords must be treated under a proposal. It is really just a proposed agreement between a debtor and its creditors upon which the creditors vote. A tenant’s proposal may range from payment of arrears over time to an outright disclaimer of its lease. Of course, the general goal of the tenant is to make the proposal attractive enough to its creditors to cause them to vote "yes" and permit the tenant to avoid bankruptcy.

The law, as it applies to a tenant’s bankruptcy, involves rather technical legislation and lease interpretation issues. Although a Landlord’s remedies may be curtailed by a bankruptcy, experienced counsel can help a Landlord navigate the various bankruptcy issues which might be raised and, in the long-run, ensure that the Landlord comes out of the process in the best position possible.

- Bill Holder

Read Bill's previous article on remedies available to a commercial landlord in the face of a defaulting tenant: A Commercial Landlord's Weapons