Lessor’s Securities in Case of Tenant Bankruptcy: Part 2 – Security Deposit
For the second article in a three-part series on lessor’s securities in the event of their tenants’ bankruptcy, today we look at the security deposit.
Didn’t read the first article? Read or re-read the article on hypothec by clicking here!
When entering into a commercial lease, it is customary for a lessor to require certain securities from the tenant as protection in case of default. These securities can take the form of a hypothec, security deposit, letter of credit, or a guarantee, among others. However, what happens to these securities when the tenant goes bankrupt?
When the tenant goes bankrupt, it significantly changes the way the securities obtained by the lessor can be enforced. Indeed, the Bankruptcy and Insolvency Act (“BIA“) now takes precedence and provides for specific mechanisms.
Part 2 – Security Deposit
For the second part of our series on the fate of the lessor’s securities in the event of tenant bankruptcy, we discuss the security deposit.
This widely used practice aims to quickly compensate the lessor in case of tenant default. In case of default, the lessor can first use the security deposit to cover the losses suffered, and then act against the tenant or exercise other securities they hold.
Additionally, even in the absence of default, the security deposit is used by the lessor when the rented premises is damaged at the end of the term, and repairs are required prior to leasing to a new tenant.
If, at the end of the lease, there is no default and the rented premises is in good condition, the security deposit is usually returned to the tenant unless otherwise stipulated in the lease.
However, as with a hypothec, there is a particular regime for a security deposit in the event of tenant bankruptcy. In the case of bankruptcy, the security deposit should normally be returned to the bankruptcy trustee upon request. In fact, to determine if the deposit can be retained by the third party, in this case, the lessor, one must consider whether the bankrupt intended to definitively part with the deposit amount. If so, then this sum has left the bankrupt’s estate, and the trustee is not entitled to it. If not, the sums still belong to the bankrupt and should be returned to the trustee. In the case of a security deposit in a lease, it is clear that a tenant does not intend to abandon this sum.
In examining our second common security in a lease, we see that bankruptcy can thwart the lessor’s right to retain the deposit made by the tenant, even if the tenant is in default.
In the next and final article, we will introduce two more common securities in non-residential leases and what happens to them in the event of bankruptcy.
__________________________________________
1 L.R.C. (1985), c. B-3.
2 PricewaterhouseCoopers inc. v. Proteau, 2018 QCCA 1415, para. 11.
