When a commercial tenant goes bankrupt, the respective rights of landlords and trustees can be complex to sort out. Yet, as illustrated by recent Ontario Superior Court decision 7636156 Canada Inc. v. OMERS Realty Corporation, 2019 ONSC 6106, this determination can have important ramifications on the assets available for distribution to creditors. This decision illustrates the difficulties encountered by parties regarding third party obligations purporting to secure a bankrupt tenants’ obligations.
The facts of this case are relatively straightforward. The bankrupt entered into a lease with OMERS Realty Corporation (the “Landlord”) in 2014. Pursuant to the lease, the bankrupt was required to provide the landlord with an unconditional letter of credit (“LoC”) in favour of the Landlord in the amount of 2.5 million which was renewed annually. The LoC provided that it was “held by landlord as security for indemnification of Landlord in respect of any losses […] resulting from […] disclaimer […] whether by Landlord […] or in connection with any insolvency or bankruptcy of the tenant or otherwise”. Bank of Nova Scotia (the “Bank”) issued the LoC and accordingly, $2.5 million was deposited by the bankrupt with Bank to secure the bank’s obligation under the LoC.
As a result of the tenants’ bankruptcy, the lease was disclaimed in 2018, and the Landlord filed a proof of claim in the amount of $623,196.84 for three months’ accelerated rent. In addition, the Landlord proceeded to draw the entire $2.5 million under the LoC for damages for, amongst other things, lost rent.
The Trustee advanced a motion for a determination of the amount the Landlord was entitled to draw down on the LoC and for an order for payment of the excess amount received by the Landlord.
The Landlord argued that the Trustee was a third party and that the Trustee could not obtain redress against the Landlord under the LoC, an autonomous contract. The Landlord relied on the 2004 Supreme Court of Canada decision Crystalline Investments Ltd. V. Domgroup Ltd. (“Crystalline”) which found that parties such as guarantors and assignors are not protected “from the consequences of an insolvent’s repudiation of a commercial lease.”
The Trustee argued that section 136(1)(f) of the Bankruptcy and Insolvency Act (“BIA”) limited the Landlord’s rights to claim for three months’ accelerated rent.
The motion judge sided with the Trustee, finding that the Landlord was only entitled to claim $623,196.84 for three months’ accelerated rent, and ordering that the Landlord pay $1,876,803.14 to the Trustee.
Jurisprudence has consistently found that following a disclaimer of a lease by a trustee, a landlord’s preferred claim is governed by section 136(1)(f) of the BIA which limits the amount of the claim to three months’ accelerated rent, and bars a damage remedy for the unexpired portion of a lease.The disclaimer operates as a voluntary surrender of the lease thereby extinguishing all obligations owed by a bankrupt tenant to the landlord under the lease.
Therefore, since the bankrupt tenant no longer owed any obligations to the Landlord after the lease was disclaimed, the Landlord was not entitled to draw on the LoC provided as security under the lease, but for three months’ accelerated rent.
The motion judge further determined that the Court’s findings in Crystalline did not apply to the Bank’s obligations in this case because all of the Bank’s obligations were “wholly dependent on the continued existence of the Bankrupt’s obligations to the Landlord”. That is, the Court found there existed no independent obligation on the Bank to make any payment under the LoC, whereas a guarantor or assignor typically assumes an independent obligation to perform a tenant’s obligations under a commercial lease.