Lessor’s Securities in Case of Tenant Bankruptcy: Part 1 – Hypothec
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?
We are pleased to present a series of three articles, each of which will address the treatment of a security granted to the lessor by the tenant when the latter 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 1 – Hypothec
It is quite common for a lessor, when granting a lease to a tenant, to want to seek a security on the tenant’s assets to protect themselves in case of non-payment of rent or failure to fulfill any other obligation. Thus, it is common to find a hypothec, most often a movable hypothec, on certain assets belonging to the tenant, in a commercial lease. A common scenario is a hypothec on the assets located within the premises. The logic behind this security is that if the tenant defaults on payment, the lessor can request or demand the termination of the lease (according to its terms) and exercise a hypothecary right on the assets within the premises to cover their claim.
However, in the event of bankruptcy, the Bankruptcy and Insolvency Act (“BIA“) must be considered, as it takes precedence due to federal jurisdiction over bankruptcy.
In this case, if the tenant had granted a hypothec to secure lease obligations, the lessor cannot enforce it in the event of bankruptcy. Indeed, the lessor is already ranked as a priority creditor under section 136(1)(f) of the BIA. Granting them the status of a secured creditor under their hypothec would undermine the priority already provided for in the BIA; therefore, the BIA must take precedence in bankruptcy cases.
Thus, the lessor holds a priority claim for an amount equivalent to three (3) months’ rent preceding the bankruptcy. Additionally, if the lease provides for rent payable in advance in the event of bankruptcy, the lessor has a priority claim for an additional three (3) months’ rent. However, the total amount that the lessor can claim under this priority “shall not exceed the realization from the property on the premises under lease”.
While a hypothec remains an interesting security, its application is limited, and even nullified, when the tenant invokes the protections of the BIA. Furthermore, even when the tenant is not bankrupt, exercising rights related to the hypothec requires certain steps (sending a prior notice of exercising a hypothecary right, applying to the Court for a surrender order, selling the assets, etc.), which other types of securities do not require. For more details on these other securities, stay tuned for our upcoming articles in this series on lessor’s securities in the event of tenant bankruptcy!
In the meantime, as always, feel free to contact a member of the real estate law team at Gascon & Associates for any questions on this subject.
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1L.R.C. (1985), c. B-3.
2L.R.C. (1985), c. B-3.
3 Constitution Act, 1867, 30 & 31 Victoria, ch. 3 (R.-U.), par. 91(21).
4Restaurant Ocean Drive inc. c. Sam Levy & associés inc., 1997 CanLII 10235 (C.A.).
5Sec. 136(1)(f) BIA.
