The Québec Court of Appeal has reiterated the objective of the protection of tenants’ rights and the stability of commercial leases with a fixed term in the case of the exercise of hypothecary rights of a secured creditor against immovable/real property.

What is the fate of a commercial lease once a secured creditor exercises its recourses and remedies pursuant to its security against the immovable/real property that is the object of the lease? The answer varies depending on whether common law or civil law applies to the lease.

At common law, if a commercial lease is entered into after the registration of a mortgage against the leased immovable/real property, the secured creditor has the right to evict the tenant after the mortgage has been enforced upon default. On the other hand, the commercial lease will have priority if it has been entered into before the registration of the mortgage on the leased immovable/real property, unless a subordination clause is agreed to by the tenant.  Such a clause has the effect of subordinating the commercial lease to the mortgage registered against the leased property in favour of the secured creditor and, thus, of ensuring that the secured creditor will be allowed to terminate the lease in the event that it elects to enforce its mortgage1.

In Québec, the Court of Appeal has recently confirmed in Urscheler 2, the interpretation that has been given by the Court of Appeal to sections 1886 and 1887 of the Civil Code of Québec (hereinafter “C.C.Q.”) in Pinkerton 3 and that has prevailed since 2004 in connection with the termination/resiliation of an immovable commercial lease with a fixed term under civil law.

The general principle under civil law is that the voluntary or forced alienation of a leased property or extinction of the lessor’s title for any other reason does not terminate the lease by operation of law 4. However, there are a few exceptions to this general principle. With respect to commercial leases with an indeterminate term, the new landlord may terminate/resiliate the lease in accordance with the provisions of the C.C.Q. and with respect to commercial leases with a fixed term, the new landlord can only terminate/resiliate the lease in certain specific circumstances. If more than 12 months remain from the date of alienation or extinction of title of the real/immovable property, the new landlord may terminate/resiliate the lease upon expiry of the 12 months by giving the tenant a written notice of 6 months. However, the new landlord may not terminate/resiliate the lease if the lease was registered at the land registry office before the “act of alienation or the act by which the title is extinguished was so registered”.

What constitutes an “act of alienation or the act by which the title is extinguished was so registered”? The Québec Court of Appeal in Urscheler reiterated that the exercise of hypothecary rights 5, with the exception made for taking possession for purposes of administration, is considered a “forced alienation” under section 1886 C.C.Q. and not merely a forced sale, since the concept of alienation is much larger than the concept of sale. Therefore, the act by which the landlord’s title is extinguished under section 1887 C.C.Q. is the prior notice of the exercise of a hypothecary right.  In other words, the new landlord who takes possession of a leased property is bound by any lease that has been published/registered before the publication/registration of the prior notice of the exercise of a hypothecary right following which it has acquired the title of the real/immovable property.

Although it may seem that this principle is prejudicial to secured creditors, the Québec Court of Appeal confirms that the principle established in the Pinkerton decision does not contravene the principle of the conservation of rights of secured creditors. This is due to the fact that the protection of tenants leads to the stabilization of commercial leases, therefore increasing the value of the financed real/immovable property.

In light of the Court of Appeal decision, how should secured creditors protect their interests in Québec when taking over a lease? Since the determining date for priority is the date of registration/publication of the prior notice of the exercise of a hypothecary right, secured creditors should ensure that no lease has been registered between the date of registration of the mortgage and the date of registration of the prior notice. The secured creditor may, however, still request the judicial termination of the lease, provided it proves the unreasonableness of the provisions of the lease and its debtor’s intent to defraud.