In the current economic climate, an increasing number of businesses may find themselves filing for bankruptcy protection under the Bankruptcy and Insolvency Act (BIA). As we know, by the time a commercial tenant files for bankruptcy, it has likely been dealing with financial difficulties for some time and has possibly accumulated significant rental arrears. This article will provide an in-depth overview of some of the most common questions that arise when a landlord receives a bankruptcy notice from a trustee for one of its commercial tenants. We will specifically focus on how the landlord will be compensated and the status of security held by the landlord (movable hypothec, security deposit, personal guarantee, and letter of credit).
RENT PAYMENTS
The landlord is entitled to a preferred claim for the following:
- Arrears of rent for a period of 3 months prior to the bankruptcy * A specific provision in the lease is not necessary to entitle a preferred claim for this amount
- Accelerated rent for a maximum of 3 months after the bankruptcy * To benefit from this, the lease MUST provide for accelerated rent
The landlord will have an ordinary unsecured claim for any other amounts owed to it, and provided for in the lease, that falls outside of the foregoing.
Q: What does having a “preferred claim” imply for the landlord?
A: Preferred creditors are reimbursed after secured creditors (and super priority claims), but before all other unsecured creditors. As the BIA does not accord the landlord a secured creditor status, it must wait in line behind secured creditors to be paid for rent amounts according to its rank among unsecured creditors.
Q: What is the scenario if the tenant has accumulated 5 months of arrears prior to the bankruptcy?
A: The landlord only has a preferred claim for 3 months of arrears. However, the landlord can claim the remaining 2 months as an ordinary unsecured creditor.
Q: The accelerated rent provision in the lease provides for 6 months of accelerated rent in the case of bankruptcy. Does this mean that the landlord has a preferred claim for 6 months of accelerated rent?
A: No. The landlord only has a preferred claim for 3 months after the bankruptcy. The landlord can still claim the remaining 3 months of accelerated rent – but as an ordinary unsecured creditor. Clearly, the foregoing also applies to an accelerated rent provision for any other amount (e.g. 9 months, or 12 months).
Q: When representing a landlord, how can I increase my client’s chances of obtaining the maximum amount under the preferred claim provisions of the BIA?
A: It’s crucial to remember that the landlord’s preferred claim for 3 months of rental arrears and 3 months accelerated rent only covers rent. Real estate taxes, OPEX, adjustments etc. should be included in the definition of “rent” in the lease (or “additional rent” with a clear indication that additional rent constitutes “rent” as defined in the lease) for the landlord to benefit from a preferred claim for these amounts.
LANDLORD SECURITY
In reality, the sale of the tenant’s assets rarely generates adequate funds to satisfy all creditor claims – which is why security becomes crucial. However, not all security instruments offer the same level of protection to the landlord in the context of the tenant’s bankruptcy. Below is an order of what typically offers the least to the most protection for the landlord.
- Movable Hypothec: A movable hypothec granted by the tenant in favor of the landlord is not enforceable against the bankrupt tenant or the trustee/creditors of the tenant, due to the federal paramountcy doctrine (federal law (BIA) takes precedence over provincial law (CCQ)).
- Security Deposit: In general, the landlord will not be able to retain the security deposit, as it will be forfeited to the bankruptcy trustee for the benefit of the mass of creditors.
- Personal Guarantee: A personal guarantee is generally a reliable way to maximize the landlord’s chances of recovering amounts due, irrespective of the tenant’s bankruptcy.
- Letter of Credit: Letters of credit are less likely to be affected by the tenant’s bankruptcy given that they are not viewed as being the property of the tenant (but rather the sums are the property of the bank), and have been recognized as security instruments that are autonomous from the lease.
Conclusion
In conclusion, understanding Landlord/Tenant Rights in a Bankruptcy/Insolvency Scenario is crucial for landlords. This understanding will not only help you protect your rights but also maximize your revenue and mitigate losses.
