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A commercial lease does not end on the sole basis that the
lessee declares bankruptcy; to the contrary, the Bankruptcy and
Insolvency Act ("BIA") provides that the property of the
bankrupt, including the lease, is vested in the trustee. In fact,
the terms of the lease are what make it possible for the lessor to
terminate the lease should the lessee declare bankruptcy.
Once the lease is terminated, the lessor has priority to recover
three months of rent due as at the date of bankruptcy; however, if
the lessor is entitled to advance rent under the lease, he will
also be able to recover three months of upcoming rent. The priority
granted to the lessor applies only to rent and does not include any
amount related to damage caused by the lessee, for which the lessor
can make an ordinary claim.
Although granting the lessor priority may seem an efficient way
to recover rent in a bankruptcy, the relative import of this must
be kept in mind, since the preferential debt payable to the lessor
can only be paid from the net equity value of the movable property,
or goods, located on the leased premises, i.e., the value after the
secured creditors who had rights on the goods have been paid. If
the value of the goods is low, the priority granted to the lessor
can be altogether worthless. Faced with this reality, can the
lessor improve his position by means of collateral securities?
There are other means by which lessors can ensure the payment of
rent, such as movable hypothec, security deposits, letters of
credit, surety bonds, etc.
Without elaborating on the debates in this regard, the movable
hypothec the lessor has over the lessee's goods is useless in a
bankruptcy, because the federal law (BIA) takes precedence over the
provincial law. The same situation exists with regard to a security
deposit since, as a security, the deposit is still considered the
property of the lessee and therefore is vested in the trustee at
the time of bankruptcy; however, this does not apply to rent paid
in advance, since it would be considered the property of the lessor
and therefore cannot be claimed by the trustee.
Third-party endorsements of rent payment, such as a surety bond
or bank letter of credit, are by far the most efficient means to
adequately compensate the lessor in the event that the lessee
declares bankruptcy, since the bankruptcy is immaterial to the
third-party agreements.
In conclusion, make sure that the lease binding you to your
lessee expressly provides for (i) termination of the lease should
the lessee declare bankruptcy; (ii) the possibility of recovering
three months of advance rent and not only the three months of rent
due as prescribed in the BIA; and (iii) if a deposit is paid, that
it is rent paid in advance and not just a security.
DID YOU KNOW?
"Entering into a contract with the limited partner of a
limited partnership cannot be equated with entering into a contract
with the limited partnership; only the general partner can bind a
limited partnership."
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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