ADVISING THE LANDLORD ON TENANT INSOLVENCY AND RESTRUCTURING*

Transcription

1 ADVISING THE LANDLORD ON TENANT INSOLVENCY AND RESTRUCTURING* by Andrew Chambers, David R.M. Jackson & David Marshall 9 th Floor St. Mary Avenue Winnipeg, Manitoba R3C 4K5 *Prepared for "OMG They're Insolvent! What Do We Do Now?" Law Society of Manitoba Continuing Legal Education Seminar, October 22, 2015, Winnipeg, Manitoba

2 In ordinary circumstances the commercial landlord-tenant relationship is extremely one-sided. In exchange for what is referred to as "quiet possession", the tenant owes the landlord a host of monetary and non-monetary obligations and covenants usually detailed in a lengthy and complex commercial lease agreement, breach of which entitles the landlord to exercise various remedies on limited notice including termination, re-entry, distress and the right to recover damages. Subject to The Landlord and Tenant Act 1 ("LTA") and a few remedial restrictions that developed in antiquity, the lease agreement dictates the landlord-tenant relationship. Tenant insolvency can significantly alter the dynamics of the lease dictated relationship in some cases effectively re-writing the lease terms and even reversing legal priorities. To further complicate this, the nature and extent of the alteration of the lease dictated relationship varies depending upon which restructuring tool the tenant is subject to, whether it be private or Court appointed receivership, bankruptcy or debtor in possession restructuring pursuant to filings under either the Bankruptcy and Insolvency Act 2 ("BIA") or the Companies Creditors Arrangement Act 3 ("CCAA"). This paper will focus upon the following key landlord considerations when a tenant becomes the subject of different restructuring tools: a) Impact upon the landlord's traditional remedies; b) Occupation rent; c) Lease disclaimers; 1 C.C.S.M. c.l70. 2 R.S.C c.b-3 as amended. 3 R.S.C c.c-36 as amended.

3 - 2 - d) Lease assignments; and e) Other covenant breaches during restructuring. Landlord's Traditional Remedies Before delving into a landlord's remedies in insolvency situations, it is useful to briefly review the pre-insolvency rights and remedies available to landlords and why they exist. The starting point is to review the lease. In addition to the numerous and sundry covenants which govern the tenant's use and occupation of the premises, commercial leases include the specific rights and remedies reserved to a landlord when default occurs, defining the events that may constitute default, and the notices that the landlord is to provide before pursuing its remedies. That said, there is no standard lease agreement. Commercial leases and lease language vary significantly and it is crucial to read the precise wording in any particular lease document carefully to ascertain the full nature and extent of the lease covenants as well as the proposed remedies. The reason for all the covenants is not just to enable the landlord to collect rent. Commercial leases contain numerous tenant covenants that are designed to protect the landlord and its investment in the property. The ability of the landlord to enforce such covenants can at times be of greater concern than mere recovery of rent. For example: 1. Duty to repair and maintain the premises. Payment of rent is of minor consequence if the premises are allowed to fall into disrepair or waste. 2. Restrictions upon what business use can be made of the premises by the tenant. For example, if the landlord is operating a shopping mall of any size it may be necessary to specifically limit the type of business that can be conducted on the premises so as not to interfere or compete with other

4 - 3 - tenants in the complex. Where another tenant has an exclusive use provision, allowing a new tenant to compete may result in the landlord being in breach of its obligations. 3. Similarly, in some larger centres, landlords may have granted covenants whereby if a major anchor-type tenant ceases to carry on business, another tenant may be entitled to stop carrying on its business or pay a reduced rent. These clauses will usually include a grace period for the landlord to find a replacement tenant, but an unanticipated bankruptcy may find the landlord caught by surprise and reduce its bargaining position to find a replacement tenant. 4. The standard covenant that the lease not be assignable by the tenant without the consent of the landlord. Clearly the landlords are concerned about the strength of the tenant they are contracting with and its ability to honour the lease terms. It would not be acceptable to the landlord if a tenant could get out of its lease obligations by simply transferring or assigning the lease to any other party without the landlord's consent. 5. Prohibitions against conducting liquidation or bankruptcy sales. It is not unusual for landlords renting to retail businesses to want to maintain a high standard for their facilities. Included in this category would be a typical covenant to operate in a manner befitting a first class retail shopping centre. From such a landlord's perspective it would reduce the value and marketability of their space to enable a tenant to promote distress sales with large banners referring to "going out of business" or "liquidation sale". The latter would also be offside signage provisions in leases which permit the landlord to strictly control and approve the type of signage used within its centre. 6. Specific restrictions regarding removal of fixtures and other property including clean-up at the conclusion of the lease. This can also include tenant covenants that they maintain a full and complete current inventory of goods within the premises. A partially empty premises, or the augmentation of inventory from other premises or that is not related to the business of the premises can be of concern to landlord and the impact it has on the image and covenants granted to other tenants. 7. Retail shopping centres will include prohibitions on construction or renovation during peak shopping seasons, such as December. Landlords will be concerned that premises taken over by an assignee not be renovated or otherwise used in a manner that would disrupt business at the centre during such periods.

5 - 4 - Through strict enforcement of such covenants, typically by the threat of lease termination and eviction, a landlord is able to maintain the integrity of its overall business operations. A landlord's interest in its property is not driven solely by the rent derived from one particular tenant. The success of shopping centres will often be the result of a designed mix of tenants as well as an overall image and reputation. There is, therefore, often a conflict between what is best for the tenant in a bankruptcy or restructuring process and what is best for the landlord; the former looks to maximize the short term revenue to the tenant or its creditors while the landlord is concerned with the long term value and image of its centre. 4 Some of a landlord's concerns in considering its position with respect to a proposed assignee of a lease are: a) does the assignee fit onto the landlord's overall strategy for the type of tenants it wishes to have and currently has in its centre? b) what is the quality of the tenant in terms of popularity and public recognition? c) what is the strength of the assignee's financial covenant? d) will the assignee put the landlord in breach of an existing covenant granted to other tenants? Or would the assignee trigger a clause in an existing tenant's lease that would allow that tenant to reduce its rent or even cease operating? 4 Murray F. Tait, "Issues in Retail Insolvencies, What are Landlords Concerned About A Business Perspective" (Paper delivered at the CBA 11 th Annual Pan-Canadian Insolvency & Restructuring Law Conference, Winnipeg, 11 September 2015), [unpublished].

6 - 5 - The image of the centre can also be affected by the manner in which business is conducted from the premises: a) landlords will not want premises to be dark for extended periods of time. b) most landlords will prohibit liquidation or bankruptcy type sales, or even tenants whose business is of that nature. c) the landlord will want to limit the hours and duration during which a going out of business sale is conducted from the premises. Landlords will therefore want to be vigilant in the restructuring process to try to ensure that it does not end up with a tenant considered undesirable to the landlord based upon factors such as financial covenant, popularity, recognition, effect on the overall tenant mix and the effect on existing covenants to other tenants. In addition, landlords will want to ensure that any actions of the tenant or Trustee are compliant with the lease terms and are carried out in a manner that does no harm the reputation or perception of the centre. Although commercial leases are now regarded as contracts which entitle the landlords to set out contractual remedies, they are also conveyances of leasehold interests of real property with many of the archaic common law notions that developed over previous millennia. 5 For example, the landlord faced with a defaulting tenant has a dilemma: does it evict the tenant or does it distrain to recover the rent arrears? These are mutually exclusive remedies. By locking out the tenant and effectively terminating the lease the landlord loses the right to distrain, which is predicated upon continuation of the lease. In order to distrain the landlord cannot prevent the tenant from occupying the 5 Highway Properties Ltd. v. Kelly Douglas & Co. [1971] S.C.R. 562.

7 - 6 - premises. If the landlord terminates the lease will it still have the right to recover the lost rent for the balance of the lease term? To some extent the draconian consequences resulting from the landlord electing to have the tenant evicted may be modified by contract provisions within the lease so as to enable the landlord to enter into the premises, evict the tenant and still recover by civil action the rent arrears and damages for the balance of the term of the lease. The primary weapon in the landlord's arsenal for maintaining compliance of tenant obligations under the lease is the threat of eviction. Whether this is based upon termination or simply a contractual right of re-entry, the ability on the part of the landlord on relatively short notice to deprive the tenant of the benefit of the lease and re-let the property to a new, hopefully more reliable, tenant provides tremendous leverage to the landlord. Where the landlord's more pressing concern is recovery of rent arrears the remedy of distress is a particularly useful tool wherein the landlord can send in a bailiff to seize the tenant's assets on the premises and, following the five day notice to the tenant, dispose of those goods and apply the proceeds against the unpaid rent. The conditions precedent to enabling the landlord to levy distress are as follows: a) There is a landlord and tenant relationship (in other words the lease has not been terminated or surrendered); b) The tenant is in possession of the rented premises; and c) There are rent arrears due and owing to the landlord breaches of the tenant's covenants other than the covenant to pay rent do not give rise to the remedy of distress. "Rent" will generally be defined by reference to the

8 - 7 - terms of the lease itself and may include such things as tax insurance and even percentage rent. 6 One of the strengths of the distress remedy is that the landlord has a first priority over secured creditors to the proceeds of the goods it distrained. 7 That priority does not extend to purchase money security interests. The right of distress is limited to recovery of no more than the preceding three months' arrears of rent unless the rent is payable less frequently than quarterly whereupon the landlord may distrain for no more than the preceding year's rent. 8 The distress must also be reasonable. 9 Typically the landlord may only distrain against those goods or chattels which are actually on the leased premises at the time of the distress. 10 There are a number of anachronistic exemptions for certain articles of personal property. 11 Also, if the assets are removed before the landlord exercises the right to distrain, that right is lost. However, if it can be asserted that the tenant fraudulently removed the goods within 30 days of the removal, the landlord may be able to follow the goods fraudulently removed. 12 Finally, the landlord always has the right to enforce covenants by civil action and in particular obtain judgment for rent arrears and, where properly provided for under the lease, damages for the balance of the lease term. 6 Brain-Hulst (1986) 59 C.B.R. (N.S.) 209 (O.N.S.C.). 7 LTA s. 37 and in particular s. 37(b). 8 LTA s. 29(1). 9 LTA s. 29(2). 10 LTA s LTA s. 36(1). 12 LTA ss

9 - 8 - Impact of Receivership Over Landlord's Remedies Receivership, in and of itself, is probably the least disruptive of the classic landlord-tenant relationship. Unlike bankruptcy, the primary statutory authorities applicable to receivership appointments do not expressly address or alter legal rights between landlords and tenants. 13 Typically a secured party remedy, Receivers may be appointed either privately or by Court Order. Where the secured party elects to proceed with a private appointment pursuant to the rights under its security, the Receiver stands in no better position than that of the tenant, absent an express postponement granted by the landlord in favour of the appointing secured creditor. There is no statutory stay of proceedings to prevent a landlord from exercising any of its remedies under the lease. In fact, most commercial leases define the appointment of a Receiver over the tenant as a lease default which entitles the landlord to terminate or otherwise enforce the terms of the lease. Accordingly, unless the privately appointed Receiver is able to negotiate consensual terms acceptable to the landlord, the landlord is otherwise free to pursue all of its usual remedies including termination, eviction, distress and suits on the lease covenants. While a Receiver may repudiate a lease in the same fashion as any other contract there is no statutory power to assign the lease and, in fact, no right to occupy the premises by voluntary payment of rent absent the express agreement of the landlord. Accordingly, where a privately appointed Receiver is unable to negotiate acceptable terms 13 Queen's Bench Act C.C.S.M. c.c-280 s. 55, BIA s. 243, The Corporations Act C.C.S.M. c.c-225 ss ; Personal Property Security Act C.C.S.M. c.p35 s. 64.

10 - 9 - with the landlord, it is not unusual for the tenant to be assigned or otherwise placed into bankruptcy in order to take advantage of the relief afforded under the BIA. Court appointed receiverships do initially provide the Receiver with temporary control over the landlord by including a stay of proceedings as a term of the Court Order which prevents all creditors from exercising their remedies until further Order of the Court. That said, whether a Receivership Order is granted under either or both BIA s. 243 and s. 55 of the Queen's Bench Act, there are no special powers over landlords inherent in the Receiver analogous to that given to Trustees in Bankruptcy. Such powers as are given are set out in the Court Order. The typical template Receivership Order 14 will include the following terms: DUTY TO PROVIDE ACCESS AND CO-OPERATION TO THE RECEIVER 7. THIS COURT ORDERS that the Receiver shall provide each of the relevant landlords with notice of the Receiver s intention to remove any fixtures from any leased premises at least seven (7) days prior to the date of the intended removal. The relevant landlord shall be entitled to have a representative present in the leased premises to observe such removal and, if the landlord disputes the Receiver s entitlement to remove any such fixture under the provisions of the lease, such fixture shall remain on the premises and shall be dealt with as agreed between any applicable secured creditors, such landlord and the Receiver, or by further Order of this Court upon application by the Receiver on at least two (2) days notice to such landlord and any such secured creditors. 14 At the current time there are no formal template Orders formulated and accepted for the Manitoba Courts. That said, current practice is to utilize the Ontario template Receivership Order as prepared and authorized by the Commercial List Users Committee of the Ontario Superior Court of Justice with the necessary amendments to comply with the laws of Manitoba.

11 NO PROCEEDINGS AGAINST THE RECEIVER 8. THIS COURT ORDERS that no proceeding or enforcement process in any court or tribunal (each, a "Proceeding"), shall be commenced or continued against the Receiver except with the written consent of the Receiver or with leave of this Court. NO PROCEEDINGS AGAINST THE DEBTOR OR THE PROPERTY 9. THIS COURT ORDERS that no Proceeding against or in respect of the Debtor or the Property shall be commenced or continued except with the written consent of the Receiver or with leave of this Court and any and all Proceedings currently under way against or in respect of the Debtor or the Property are hereby stayed and suspended pending further Order of this Court. NO EXERCISE OF RIGHTS OR REMEDIES 10. THIS COURT ORDERS that all rights and remedies against the Debtor, the Receiver, or affecting the Property, are hereby stayed and suspended except with the written consent of the Receiver or leave of this Court, provided however that this stay and suspension does not apply in respect of any "eligible financial contract" as defined in the BIA, and further provided that nothing in this paragraph shall (i) empower the Receiver or the Debtor to carry on any business which the Debtor is not lawfully entitled to carry on, (ii) exempt the Receiver or the Debtor from compliance with statutory or regulatory provisions relating to health, safety or the environment, (iii) prevent the filing of any registration to preserve or perfect a security interest, or (iv) prevent the registration of a claim for lien. NO INTERFERENCE WITH THE RECEIVER 11. THIS COURT ORDERS that no Person shall discontinue, fail to honour, alter, interfere with, repudiate, terminate or cease to perform any right, renewal right, contract, agreement, licence or permit in favour of or held by the Debtor, without written consent of the Receiver or leave of this Court. That said, the Receiver cannot continue to occupy the leased premises indefinitely without making satisfactory arrangements for payment of rent with the landlord. If a satisfactory agreement is not reached the landlord is entitled to bring a motion

12 to lift the stay and allow it to proceed with its usual remedies. Similar to privately appointed Receiver, the Court appointed Receiver may repudiate the lease but has no additional authority to compel an assignment of the lease to a prospective buyer of the business or to another business that may be prepared to pay a premium to acquire the location from the Receiver. Furthermore, a Court appointed receivership, just like a privately appointed receivership, does not alter priorities between landlords and secured creditors and therefore the landlord's right to the proceeds from distraint for pre-filing rent arrears over the goods in the premises is not affected. If an agreement between the landlord and the Receiver cannot be reached on this issue, the landlord may apply to Court to lift the stay and allow it to proceed with its remedies. 15 What Happens When the Tenant Becomes a Bankrupt? There is a fundamental shift in both the underlying philosophy and legislative policy when a tenant becomes bankrupt. Whereas the traditional landlord-tenant relationship is premised on protection and preservation of the landlord's real property rights, bankruptcy's focus is on the rights of creditors generally of which the landlord is only one of many. For the most part, the bankruptcy regime is focused on maximizing recovery for the overall benefit of creditors and, with very few specific exceptions, is focused on equal or pro rata sharing between them. To properly do this, the rights of 15 CIBC v Manitoba (1991) 2 C.B.R. (3d) 4 (M.B.C.A.).

13 individual creditors are often sacrificed for the benefit of the larger group. The point being that the landlord who thought it had an arsenal of remedies available against the tenant is now unable to act unilaterally. From a legal perspective, it is also important to recognize that while landlord-tenant law is constitutionally a matter of provincial jurisdiction, bankruptcy is federal and that includes all the interpretive aspects that go with it, in particular the doctrine of paramountcy of federal legislation. Interestingly, BIA s. 146 states that the rights of lessors are to be determined according to the law of the province in which the leased premises are situated. However, that section is expressly subject to the following exceptions: a) Priorities and rankings as provided by s. 136; b) The effect of bankruptcy on distress rights under BIA s. 73(4); and c) The Trustee's right to assign leases under BIA s On a more practical level a tenant's bankruptcy has several immediate as well as long term consequences to the landlord. Firstly, there is an automatic stay of proceedings against all creditors. BIA s provides that "no creditor has any remedy against the debtor or the debtor's property, or shall commence or continue any action, execution or other proceedings, for the recovery of the claim provable in bankruptcy". In other words, the landlord is prohibited from terminating the lease, evicting the defaulting tenant, distraining for rent or otherwise taking most forms of legal action for pre-filing defaults.

14 While BIA s contemplates that any creditor may apply to "lift the stay," such applications are rarely granted save and except where it is necessary to ultimately quantify the amount of the tenant's liability under the lease for claims purposes. 16 However, lifting the stay would not assist the landlord with its distress remedy. Firstly, that remedy is effectively lost by the fact that under BIA s. 71(2) all property of the bankruptcy vests in the Trustee from the date of bankruptcy and thus there is no longer property of the bankrupt tenant that satisfies the necessary definition of being the subject to a landlord's distress. More practically speaking, even if the landlord could distrain, the proceeds would be subject to the prior rights of secured creditors as BIA s. 136 dictates priority rankings. An interesting question is often posed about whether the landlord should rush to distrain before a tenant is placed into bankruptcy. Without getting into the merits of such an approach it must be recognized that until such time as the distress is fully completed - i.e. the distrained goods sold and the landlord in actual receipt of the proceeds, a bankruptcy occurring at any time prior thereto will result in the proceeds becoming the property of the Trustee. 17 Even where the distress has been completed and the landlord paid, there remains a risk that a Trustee in Bankruptcy may challenge the distress process as a preference under the BIA regime. 18 The landlord's next concern is how long can the Trustee in Bankruptcy occupy the premises and is it entitled to stay there if the rent is not being paid. Firstly, once 16 See for example, Re Buchanan (2007) 32 C.B.R. (5 th ) 1 (N.S.C.A.). 17 BIA s. 73(4); Frank Bennett "The Landlord's Right of Distress and the Trustee in Bankruptcy" 15 C.B.R. (N.S.) 209 at para Warran Whillan Enterprises v. Gazzola [1989] 5 W.W.R. 740.

15 the Trustee takes possession and occupies the premises, the Bankruptcy Estate is liable for the post-filing rent accruing. 19 There remains some dispute as to whether or not Trustees are personally liable for occupation rent if there is not sufficient assets in the Bankruptcy Estate to pay. Accordingly, it is useful for landlords to have some comfort that the Trustee's commitment to pay occupation rent has some substance behind it. 20 Failure to receive actual rent payments on a timely basis following formal demands upon the Trustee should prompt a court application to force the issue. The landlord and the Trustee may also disagree as to the quantum of occupation rent. While occupation rent is generally derived from the rent payable under the lease, 21 the language used may be open to interpretation and prompt the Trustee to challenge the inclusion of certain charges under the definition of "rent". Where the lease provides for percentage rent, Courts have compelled that percentage rent be paid by the Trustee in occupation. 22 As a Trustee has no higher entitlement than the debtor in respect of a lease, the Courts will not allow the Trustee to set off its obligations. 23 An interesting point is whether or not the Trustee is in actual occupation of the premises so as to entitle the landlord to receipt of occupation rent during the bankruptcy. 19 Re Baseline Industries (1994) 29 C.B.R. (3d) 65 (B.C.S.C.). 20 Re Yonemitsu Investments Ltd. (1992) 14 C.B.R. (3d) 275 but see Manitoba Ltd. (Otto Re-Nu) [1983] 5 W.W. R. 270 (N.B.Q.B.) affirmed [1983] 5 W.W.R. 270 (M.B.C.A.). 21 Re Murray & Co (1934) 16 C.B.R Provost Shoe Shops v. Marlborough Properties (1993) 21 C.B.R. (3d) 153 (N.S.S.C.). 23 Houlden & Morawetz, Bankruptcy and Insolvency Analysis at G-129.

16 Immediately upon the initial assignment, the Trustee may or may not have decided to enter into occupation. Occupation is typically determined based upon a number of factors of which no one in particular is determinative 24 including: a) Changing of the locks; b) Keeping the estate assets on the premises; c) Bringing prospective purchasers to the premises to inspect assets; d) Performing maintenance on the premises; and e) Conducting reviews of inventory on the premises. While rent payment for the Trustee's occupation is of initial concern, it is not long before the landlord also wants to know whether and when it can re-enter and relet the premises to a new tenant. As discussed below, the Trustee has the right to disclaim the lease and where the business in question is being liquidated it is not unusual for the Trustee to advise the landlord that it will be vacating the premises following the first creditor's meeting, which meeting must occur within 21 days of the bankruptcy. However, there are provisions within both the LTA and the BIA which enable the Trustee to not only elect to retain or disclaim the leased premises, but to take up to three months before having to make the election. Specifically LTA s. 46(2) provides that a Trustee has up to three months to determine whether to retain, surrender possession of or disclaim the leased premises for the whole or any portion of the unexpired term and any renewal of the lease. If the Trustee 24 Houlden & Morawetz, Supra at G-128.

17 does not actually occupy the premises there is case law supporting the position that the Trustee is not required to pay rent for the period of time it takes to make the election. 25 That said, the Trustee must within a reasonable time affirm or disclaim contracts entered into by a bankrupt, including leases. 26 The Trustee cannot choose to do nothing as the counter-party is entitled to know its position. Once the Trustee affirms the contract it is bound to perform it. If the Trustee disclaims the lease this gives rise to the landlord's claim against the bankruptcy estate for rent arrears and other damages though it is important to bear in mind that any claim for prospective damages is lost as the balance of the lease term is extinguished. 27 The Trustee's right to elect to retain the lease includes the right to assign the lease, together with any rights of renewal, to a party that otherwise complies with the statutory requirements of LTA s. 46(2), even against the express objection of the landlord. In other words, this specifically overrides the typical standard lease provision that prohibits the tenant from making an assignment of the lease without the express consent of the landlord. While LTA s.46(2) also provides the traditional test for the Trustee to compel assignment of the lease without the landlord's consent, that test been replaced by BIA s Under BIA s.84.1 a Trustee may assign almost any contract, including leases, notwithstanding the objection of the landlord provided that: a) All monetary defaults in relation to the agreement will be remedied; 25 See for example Re Walsh (1924) 5 C.B.R. 27 (O.N.S.C.); Kappa Corp. v. Douglas Shopping Centre (1994) 28 C.B.R. (3d) 241 (B.C.C.A.); Village Shopping Centre v. Thorne Riddell Inc. (1989) 75 C.B.R. (NS) 281; Re: Bad Boy (1977) 35 C.B.R. (NS) 111 (O.N.S.C.). 26 Houlden & Morawetz, Supra G Re Solok Hotel Co. (1967) 11 C.B.R. (NS) 92; affirmed (1967) 11 C.B.R. (NS) 158 (M.B.C.A.).

18 b) The proposed assignee to whom the rights and obligations are to be assigned is "able to perform the obligations"; and c) It is appropriate to assign the rights and obligations to that person. This does place a fair amount of discretion upon the presiding Judge but Jurisprudence to date favours approval for such assignments notwithstanding the opposition of counterparties, provided the overall result is in the best interest of all of the stakeholders. 28 In particular, the determination of whether it would be "appropriate" to assign a lease will include the impact on a landlord as well as the overall restructuring of the bankruptcy estate, and in considering the latter, it may be more difficult for landlords to be successful in objecting to an assignment. It should be recognized that where a landlord has properly terminated the lease prior to bankruptcy, there is no longer a current lease for the Trustee to acquire any special rights under the BIA or the LTA. 29 That said, depending on the type of breach and the timing of termination in relation to the bankruptcy, the Court may potentially grant the Trustee in Bankruptcy relief from forfeiture and reinstate the lease. 30 Aside from the above outlined restrictions, the Trustee has no higher entitlement than the debtor in respect of the lease. As a result, the Trustee that occupies the premises and/or elects to retain the lease is still bound by its covenants. While that does not permit the landlord to immediately enforce the agreement with its traditional remedies as against the Bankruptcy Trustee without first obtaining leave of the Court, 31 the 28 See for example Ford Credit Canada Ltd. v. Welcome Ford Sales 2011 (A.B.C.A.) Re: Custom Cresting (1975) 19 C.B.R. (NS) 282; Canadian Petcetera v R. Holdings Ltd. (2010) 70 C.B.R. (5 th ) 181 (B.C.C.A.). 30 Canadian Petcetera, Supra. 31 BIA s. 215.

19 bankruptcy estate will be required to honour the lease covenants, until such time as the lease has been disclaimed. Debtor in Possession Restructuring It has become common in recent years for insolvent businesses to voluntarily apply for protection under either the BIA or CCAA. This enables the debtor to restructure its affairs without the need for bankruptcy per se and/or receivership. Subject to the oversight of a court officer (Proposal Trustee or Monitor depending upon the regime), it is the debtor who continues to control and operate the business throughout the process. While these regimes tend to avoid the stigma of "bankruptcy" they both provide very similar restrictions upon the landlord's rights as occurs in bankruptcy. From a policy perspective, the Court's concern when assessing the appropriateness of the relief sought is not just the impact upon the creditors but upon all other stakeholders as well, including employees, suppliers and the community at large. The point being that the landlord's interest becomes only one of many to be considered when the court adjudicates these matters. BIA Proposals and NOIs The 1992 and subsequent amendments to the BIA have established a regime where insolvent debtors can obtain protection from their creditors, in particular a stay of proceedings and ancillary relief, to enable the troubled debtor to try to reorganize its affairs. This process taken under Division I of the BIA ultimately allows the debtor to make a formal proposal to its creditors to avoid bankruptcy. In order to make it an even more flexible process, the troubled debtor may obtain the protections and most of the relief

20 available under this legislation by simply filing a Notice of Intention to Make a Proposal ("NOI"). On filing a proposal or a NOI, an automatic stay of proceedings is imposed upon the creditors including the landlord. 32 This stay applies to the landlord's claims in respect of any pre-filing defaults. 33 While landlords, like all creditors, have the right to seek leave to lift the stay as it applies to them, the Court must be satisfied that there is significant financial hardship or material prejudice, the result of which is that a stay would only be granted in the most exceptional circumstances. The stay imposed upon filing an NOI, however, is of limited duration 30 days initially, with discretion to the court to grant 45 day extensions up to a maximum of 6 months. If the debtor does not file a proposal within that time frame it will be deemed bankrupt. At each stay extension hearing the court must be satisfied that the debtor is continuing to proceed in good faith with some prospect of completing a proposal for the creditors. At each hearing the creditors have the opportunity to raise any objections. That said, BIA s. 65.1(2) provides a very interesting clarification regarding the stay imposed under this regime. This section prohibits any person from terminating or amending any agreement, including a lease, based upon the fact that the tenant is insolvent, has filed the proposal/noi or has not paid rent or other payments of similar nature "in respect of the period preceding" the BIA filing. What this means is that where the insolvent tenant under this process fails to make satisfactory arrangements for payment of rent due 32 BIA s. 69.1(1) and s Westcraft Manufacturing (1994) 27 C.B.R. (3d) 28 (B.C.S.C.).

21 or accruing due after filing or there are other post-filing defaults the landlord may proceed with its other remedies including termination without the need to seek leave of the court to lift the stay. 34 In order to assist the restructuring this legislation provides the debtor with the right to disclaim contracts including leases. This makes it a very useful device for retail businesses with multiple locations to downsize. BIA s. 65.2(1) provides that any time after filing the NOI, and before filing of any proposal, the tenant may disclaim leases upon 30 days' notice to the landlord in the prescribed form. The landlord has a right under BIA s. 65.2(2) to seek a declaration that s. 65.2(1) does not apply to it within 15 days. Where such an application is made the onus is on the tenant to show that its proposal would not be viable without disclaiming the lease. 35 The Court must assess the likelihood of the success of the debtor's proposal. Where the tenant successfully disclaims the lease, BIA s. 65.2(4)(b) prevents the landlord from claiming accelerated rent but does entitle the landlord to file a Proof of Claim in the Proposal for any actual losses it suffered as a result of the disclaimer or for an amount equal to the lesser of (i) the aggregate of the rent (at the lease rate) for the first year following the disclaimer date, and 15 percent of the rent for the remainder of the term of the lease after that year or (ii) the next three year's rent. That said, such claim is an unsecured claim in the proposal. To further facilitate the debtor's restructuring efforts, the debtor may also assign the lease without the landlord's consent provided the Court approves. BIA s. 66(1.1) 34 Petcetera, Supra. 35 Re Superstar Group of Companies (2001) 25 C.B.R. 4 th 119 (B.C.S.C.).

22 expressly authorizes the debtor to take advantage of BIA s to compel assignment of agreements including leases provided: a) The Proposal Trustee approves of the assignment; b) All monetary defaults are cured; c) The assignee is able to perform the obligations under the lease; and d) It is "appropriate to assign the rights and obligations to" the assignee. CCAA Companies with debts exceeding $5 million may restructure under CCAA and obtain similar relief to that provided under the BIA proposal regime. CCAA is much less codified than the BIA and therefore provides the debtor and the Court with far more flexibility to craft the specific protections and restructuring powers in the CCAA Order. Over the last decade some of the more distinctly anti-landlord provisions that previously found their way into CCAA Orders have been tempered through the use of the template orders prepared under the guidance of the Ontario Commercial List Users Committee. For example, the template order has several express provisions that directly clarify certain aspects of the landlord and tenant relationship during the CCAA proceedings including: POSSESSION OF PROPERTY AND OPERATIONS 9. THIS COURT ORDERS that until a real property lease is disclaimed [or resiliated] 36 in accordance with the CCAA, the Applicant shall pay all amounts constituting rent or payable as rent under real property leases (including, for greater certainty, common area maintenance charges, utilities and realty taxes and any other 36 The term "resiliate" should remain if there are leased premises in the Province of Quebec, but can otherwise be removed.

23 amounts payable to the landlord under the lease) or as otherwise may be negotiated between the Applicant and the landlord from time to time ("Rent"), for the period commencing from and including the date of this Order, twice-monthly in equal payments on the first and fifteenth day of each month, in advance (but not in arrears). On the date of the first of such payments, any Rent relating to the period commencing from and including the date of this Order shall also be paid. RESTRUCTURING 12. THIS COURT ORDERS that the Applicant shall provide each of the relevant landlords with notice of the Applicant s intention to remove any fixtures from any leased premises at least seven (7) days prior to the date of the intended removal. The relevant landlord shall be entitled to have a representative present in the leased premises to observe such removal and, if the landlord disputes the Applicant s entitlement to remove any such fixture under the provisions of the lease, such fixture shall remain on the premises and shall be dealt with as agreed between any applicable secured creditors, such landlord and the Applicant, or by further Order of this Court upon application by the Applicant on at least two (2) days notice to such landlord and any such secured creditors. If the Applicant disclaims [or resiliates] the lease governing such leased premises in accordance with Section 32 of the CCAA, it shall not be required to pay Rent under such lease pending resolution of any such dispute (other than Rent payable for the notice period provided for in Section 32(5) of the CCAA), and the disclaimer [or resiliation] of the lease shall be without prejudice to the Applicant's claim to the fixtures in dispute. 13. THIS COURT ORDERS that if a notice of disclaimer [or resiliation] is delivered pursuant to Section 32 of the CCAA, then (a) during the notice period prior to the effective time of the disclaimer [or resiliation], the landlord may show the affected leased premises to prospective tenants during normal business hours, on giving the Applicant and the Monitor 24 hours' prior written notice, and (b) at the effective time of the disclaimer [or resiliation], the relevant landlord shall be entitled to take possession of any such leased premises without waiver of or prejudice to any claims or rights such landlord may have against the Applicant in respect of such lease or leased premises, provided that nothing herein shall relieve such landlord of its obligation to mitigate any damages claimed in connection therewith.

24 CCAA s expressly empowers the Court to order stays of proceedings. The stay provisions set out in the template orders for the most part mirror those contained in the template receivership orders set out previously and prevent landlords from accelerating, terminating, suspending, modifying or cancelling leases or otherwise disturbing or interfering with the occupation by the tenant and the premises or taking other proceedings without the express consent of the tenant and Court appointed Monitor unless otherwise ordered by the Court. Certainly any creditor can bring a motion to lift the stay of proceedings, however, if lifting the stay has the effect of jeopardizing the potential restructuring the Court will refuse the motion. The test on whether to lift the stay is a question of relative prejudice to the landlord and the tenant. 37 Unlike the BIA proposal regime there is no set deadline for completing the restructuring process. Although initial CCAA Orders cannot grant a stay for more than 30 days, the Court can extend the stay on subsequent debtor motions without an absolute time limit provided the Court is satisfied the debtor continues to act in good faith and with due diligence in its restructuring efforts and that the stay continues to be appropriate. 38 As contemplated by the specific provisions of the template order detailed above the tenant who wishes to continue to occupy premises must continue to pay the rent accruing after filing. Failure to pay the rent would constitute a default. However, unlike the situation in a BIA proposal, the landlord cannot proceed with its default remedies without either the tenant's and Monitor's consent or leave of the Court Order. 37 Re Canwest Global Communications Corp CanLII 7058 (Ont.S.C.J.). 38 CCAA s (3).

25 CCAA s. 32 (much like BIA s. 65.2) authorizes the tenant to disclaim contracts, including leases though unlike BIA s.65(2) there is no prescribed formula for calculating prospective damages for the balance of the lease term thus leaving the issue open to be addressed in the Plan of Arrangement, if one is filed. Provided the Monitor approves, the tenant may issue a notice of disclaimer. The landlord has the right within 15 days of such notice to bring a motion to Court for an Order preventing the disclaimer from taking effect. It is also important to note that the landlord may request written reasons from the tenant for the disclaimer which the tenant must answer within 5 days. 39 If the landlord does not bring a motion to Court within the 15 day time period the lease is deemed to be disclaimed 30 days after the day on which the notice was provided. If the landlord does go to Court the Court will consider whether the disclaimer is necessary based upon: a) The Monitor's approval of the proposed disclaimer; b) Whether the disclaimer would enhance the prospects of a viable compromise or arrangement being made; and c) Whether the disclaimer would likely cause a significant financial hardship to the landlord. CCAA 11.3 provides that the Court may make an Order assigning the rights and obligations of contracts, including leases where the landlord does not voluntarily consent. Similar to the provisions in the BIA regime the Court may not make the Order unless it is satisfied that: a) All monetary defaults are paid; b) The Monitor approves the assignment; c) The assignee would be able to perform the obligations under the lease; and 39 CCAA s. 32(8).

26 d) It would be appropriate to assign the rights and obligations to the assignee. In exercising this test the Court will have to weigh the relative prejudice between the objecting landlord and the best interests of all the stakeholders. Similar to the BIA proposal regime the Courts have fairly consistently approved such assignments notwithstanding counter-parties' objections, provided there is an overall benefit to the general body of stakeholders. The law is clear that aside from the pre-filing defaults, debtors in CCAA are bound to abide by the lease terms until such time as the lease is disclaimed. 40 Conclusion Clearly a landlord's traditional remedies are significantly restricted once a tenant is subject to formal restructuring proceedings, whether it be bankruptcy, BIA proposal or CCAA. Different considerations apply to the landlord's approach at each stage of the relationship. When entering into a lease with a new tenant it is wise to review the document to ensure the language is strong and appropriate to maximize leverage. For example, for landlords adverse to having a potential bankruptcy trustee control the unexpired term of the lease, consideration could be made to amending the insolvency covenant from giving the landlord the option to terminate on a tenant's bankruptcy to instead declaring that event to automatically terminate the lease. Another example is while the landlord may technically lose the right to distrain and the priority that comes with it on 40 David B. Bish "Who's in the Driver's Seat?" A Landlord's Perspective on Retail Tenant's Insolvency Proceedings" (2008) 42 C.B.R. (5th) 159.

27 bankruptcy, it is entitled to preferred status for the rent due and unpaid during the three month period preceding the date of the bankruptcy together with accelerated rent if the lease provides for it. Accordingly, the lease should be worded to include an acceleration clause. Similarly, the lease should broadly define "Rent" so that it covers any other payment obligations under the lease. An example of wording that attempts to be all inclusive is as follows: "Additional Rent means all amounts (other than Basic Rent) payable by the tenant to the landlord pursuant to this lease, whether or not specifically designated as Additional Rent" In turn "Rent" should be defined to mean Basic Rent as well as Additional Rent. Where a landlord is concerned that an existing tenant may be insolvent and thus at risk of being the subject of restructuring proceedings being taken, it may be useful to consider: 1. If the major concern is the existing rent arrears, and there appears to be sufficient property of the tenant on the premises to effect payment by levying distress, consideration could be made to taking such action on an expedited basis. 2. If the landlord's concern is that formal proceedings may prevent it from ridding of itself of an otherwise undesirable tenant and finding a stronger replacement tenant, promptly proceeding with formal notice of termination may avoid the risk of being held captive in a restructuring process until its conclusion. If the tenant has already obtained some measure of formal protection under one of the insolvency regimes, then while it may be too late to distrain or terminate, the landlord must be particularly vigilant in protecting its rights. For example:

28 Ensure that post-filing rent obligations are kept current, failing which diligently press the tenant and the applicable Court officer overseeing the process to ensure payment is made, failing which an application to the Court should be made for appropriate relief. 2. Make certain that all other covenants are being properly honoured and maintained, failing which formal default notices should be provided to the tenant and the applicable Court officer. Again, if these defaults are not addressed on a timely basis, apply to Court where necessary. 3. Maintain an open and friendly dialogue with the applicable Court officer. In this fashion the landlord can stay on top and possibly anticipate upcoming proceedings and encourage the tenant and the Court officer to keep the landlord's interests in mind. For example, if it looks like the ultimate plan does not contemplate long term retention of the premises then the tenant should be encouraged to disclaim sooner rather than later. If it appears that a sale transaction is contemplated which may involve potentially assigning the lease to a buyer, get as much information as possible to determine if the proposed buyer may in fact have a stronger ability to honour the original lease than the existing tenant, in which case support the sale and ensure that the usual covenants are met, including payment of all pre-filing monetary obligations. 4. If it appears there will be a liquidation of the tenant's assets, then particular care should be taken to remind the tenant and the Court officer of any restrictions thereto under the lease, and encourage the process to be completed promptly with a lease disclaimer to follow thereafter. If it appears that the tenant will be engaging a private liquidator and Court approval is sought in the process, carefully review any contemplated Court Order to ensure that the court's approval of the liquidation engagement does not breach existing lease covenants. 5. In the event there is a Court Order to compel assignment of the lease, study the language of the Order diligently to ensure that it does not purport to negate any non-monetary obligations under the existing lease or ratify existing breaches. An assignee of the lease should not be able to pick and choose what ongoing lease obligations it assumes.