Lessor’s Securities in Case of Tenant Bankruptcy: Part 3 –  Letter of Credit and Guarantee

In this third and final article on the subject of lessor’s securities in the event of their tenants’ bankruptcy, we look at letters of credit and guarantee.

Would you like to read or re-read the first two parts of the series?

Part 1 – Hypothec

Part 2 – Security deposit

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 3 – Letter of Credit and Guarantee

In the previous two articles, we explored what happens in the event of tenant bankruptcy with two securities commonly requested by lessors:  the hypothec and the security deposit.

Today, we will discuss two other popular securities:  the letter of credit from the tenant’s financial institution and the third-party guarantee.

A notable difference should be highlighted here; unlike the hypothec and security deposit, where the tenant provides the security, in these two cases, it involves a third party’s commitment (the bank or the guarantor) to the lessor. This distinction will impact the treatment of these securities in the event of bankruptcy.

First, regarding the letter of credit (or letter of guarantee) issued by the tenant’s financial institution, it remains enforceable in the event of the debtor’s bankruptcy as it is a third-party commitment. Since it is typically a firm commitment by the bank to pay the funds mentioned therein once the conditions are met, the tenant’s bankruptcy does not impact the validity of the letter.

An important caveat, however, is to check the wording of the letter to ensure that it is not subject to conditions that would render its exercise invalid in the event of bankruptcy. Furthermore, it is essential to verify whether the letter has an expiration date and that all conditions are met for the bank to authorize the release of funds.

Finally, the guarantee follows the same logic as the letter of credit since it is also a third-party commitment; this is actually one of the main reasons why a lessor requests a third-party guarantee, to protect themselves in case of tenant bankruptcy or insolvency.

The guarantee will thus remain valid even after the tenant’s bankruptcy, subject to the specific terms of the guarantee, including its expiration or any particular conditions.

This is a brief overview of the fate of the main securities a lessor holds in case of tenant bankruptcy. The hypothec and security deposit are very common and attractive securities for a lessor, but their usefulness significantly decreases in the event of bankruptcy. The guarantee and letter of guarantee typically endure beyond bankruptcy and remain attractive outside of bankruptcy, but because of this, a tenant will likely be more reluctant to provide them. A good practice for both lessors and tenants would be to include different types of securities in the lease to allow for compensation, regardless of the situation causing the tenant’s default.

For any questions regarding your commercial leases and the remedies available to you, feel free to contact a member of the real estate law team at Gascon & Associates.

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 ¹ R.S.C. (1985), c. B-3.

² Miller McClelland Ltd. v. Pensionfund Properties, 1998 ABCA 287, para. 16 ; Jacques DESLAURIERS, La faillite et l’insolvabilité au Québec, 2e éd., 2011, para. 2001