Canada: Lease Assignments in Bankruptcy and Insolvency: Where Do We Go From Here?

Copyright 2010, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Real Estate, April 2010

In September 2009, amendments to the Bankruptcy and Insolvency Act (Canada) (BIA) and the Companies' Creditors Arrangement Act (Canada) (CCAA) came into effect that gave trustees in bankruptcy and debtors the specific right to assign leases in the course of their bankruptcy or insolvency proceedings. The result, rather than providing some certainty on the matter, is to significantly muddy the waters for landlords seeking to protect themselves and to raise questions as to who are appropriate persons to whom leases can be assigned in bankruptcy and insolvency proceedings.

Prior to the legislative amendments, the assignment of leases could only be effected by court order and with reliance upon the provisions of individual pieces of provincial legislation. In Ontario, for example, section 38(2) of the Commercial Tenancies Act (CTA) permitted a trustee in bankruptcy to assign the lease to any other party upon the consent of the landlord or the approval of the court and upon fulfilling certain conditions (such as paying all arrears of rent). This provision effectively overrode any provisions in the lease to the contrary. Nonetheless, landlords took comfort in that the CTA required that the assignee be a person who was proven to be a "person fit and proper to be put in possession" and that such person could prove that its intended use would not be "more objectionable or hazardous" than the present use under the lease. Moreover, a well-developed line of case law had been established that gave landlords some comfort that the terms of the lease would not be amended wholesale as a result of the bankruptcy or insolvency of the tenant. Rather, the courts tended to focus on ensuring that the landlord ended up with a deal roughly equivalent to what it started with: namely, a tenant with the financial capability to perform all of its obligations under the lease (including abiding by the use clause of the lease).

The new insolvency legislation amendments, however, have thrown the developed case law in every province into some disarray. In particular, the new section 84.1 of the BIA provides:

An almost identical provision can be found in the new section 11.3 of the CCAA. Unfortunately, given the newness of the legislation, there are not yet any reported cases that have considered these amendments. It therefore remains to be seen how the courts will interpret the many questions raised by the new legislation.

First and foremost is the question of whether or not these provisions even apply to leases. Both the BIA and the CCAA provisions each make clear that they do not apply to "agreements that are not assignable by their nature." Do leases, which often provide that they are not assignable without consent, fall within this category? This would seem to render the provisions meaningless, although it raises an important question of what it means to have an agreement that is not assignable by its nature. Does this mean only personal licences or personal service agreements? Or does it also include agreements that are not assignable by their terms and by the agreement of the parties? Given that the previous incarnation of this amendment specifically excluded commercial leases – an exclusion that was erased by the amendments set forth in the recent Economic Recovery Act (Canada) – this argument is unlikely to succeed. If Parliament had meant to exclude leases, it could have done so more clearly (and had done so, previously).

Secondly, if the legislation is applicable to leases (which is almost certain), the legislation creates some uncertainty as to whom the lease may be assigned. The legislation makes clear that a court may consider, among other things, whether the proposed assignee is "able to perform the obligations" and whether "it would be appropriate" to assign the lease to that person. While these considerations seem to indicate a legislative intent to import a "fit and proper person" test, the wording points to a much less exacting standard. Additionally, it is to be noted that the court may consider these factors "among other things," which lends itself to the expectation that courts may also consider any number of other factors, including the potential impact on the bankrupt or debtor's restructuring plan or the impact on other creditors. There is a very real risk that courts may be tempted to rewrite leases, particularly those that are above market, for the benefit of the greater good of a pool of creditors or a struggling debtor. For landlords, this risk may taint otherwise advantageous deals.

Finally, the new legislative amendments make clear that monetary defaults, such as arrears of rent, will need to be cured prior to assignment. Or do they? Look carefully. The court is to ensure that monetary defaults are cured, except "those arising by reason only of the person's bankruptcy, insolvency or failure to perform non-monetary obligations." Did the arrears of rent arise because of the tenant's bankruptcy? Some monetary defaults, such as the obligation to pay three months' accelerated rent or the requirement to pay back the unamortized costs of leasehold improvement allowances, typically only arise on the tenant's bankruptcy or insolvency, and the legislative amendments would suggest that they do not need to be paid. Additionally, the legislative amendments suggest that bankruptcy or insolvency stops the clock on arrears of rent, forgiving everything arising after the date of filing. Indeed, if one is to take the interpretation to the extreme, it might also be possible to argue that any arrears of rent should be forgiven (regardless of the formal date of filing), given that the very inability to pay rent is often one of the hallmarks of an insolvent or bankrupt person. For landlords in jurisdictions where the requirement to pay arrears is not necessarily a precondition of assignment in bankruptcy or insolvency, such as British Columbia, this will not necessarily seem out of order. But for landlords where payment of arrears was a necessary precondition of assignment, such as Ontario, this will appear as an unwelcome step backward.

This discrepancy reveals a problem at the very heart of the new legislative amendments. By choosing the lowest common denominator between the provincial requirements, the federal legislation has exposed the inequity among them. And by leaving some landlords worse off than they were before, the new amendments will inevitably raise a question as to whether or not it is appropriate for the federal government to be legislating in an area that was adequately (albeit unevenly) being dealt with before by the provinces. Indeed, previous attempts by the federal government to include similar provisions in the BIA were struck down by the courts in 1929 as being outside the legislative scope of the federal government and belonging instead to the provincial sphere of influence over property and civil rights. It is certainly therefore open to landlords to argue that the new amendments are beyond the powers or legal authority of the federal government.

In the meantime, however, landlords are left with an uncertain legislative landscape and questions as to how best to protect themselves. Prudent landlords should consider carefully crafting use provisions to make clear not only what uses are permitted, but what uses are prohibited, particularly outlining any restrictive covenants or exclusives the landlord has granted to third parties. In doing so, the lease may send a strong signal to the courts of what effect their interference might cause.

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