Sigh Of Relief For Commercial Landlords: Letters Of Credit Unaffected By A Tenant's Bankruptcy

• Published date: 07 December 2020
• Subject Matter: Real Estate and Construction, Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy, Landlord & Tenant - Leases
• Law Firm: McCarthy Tétrault LLP
• Author: Restructuring Roundup and Alexander Steele

The Ontario Court of Appeal, in 7636156 Canada Inc. (Re), 2020 ONCA 681 ("7636156"), recently affirmed the autonomy of documentary letters of credit as valid security for the obligations of a tenant under a commercial lease when that lease is disclaimed by the tenant or the tenant's trustee in bankruptcy. This is good news for landlords as it resolves previous uncertainty regarding a landlord's ability to rely on a stand-by letter of credit as collateral security in connection with a lease transaction. Subject to the "fraud exception" to the autonomy of letters of credit, and provided that the lease and the letter of credit are properly drafted, the Court of Appeal has confirmed that a landlord will be entitled to call on the letter of credit to satisfy its claim for losses arising from the disclaimer or termination of a tenant's lease in an insolvency proceeding.

In so finding, the Court of Appeal overturned the decision of the motion judge that limited the landlord's recovery to the three-months' accelerated rent claim allowed by section 136(1)(f) of the Bankruptcy and Insolvency Act ("BIA").

In 7636156, the tenant ("Tenant") leased an industrial building from the landlord ("Landlord") on a ten-year term expiring in May 2024. In May of 2018, the Tenant made an assignment into bankruptcy and a trustee was appointed ("Trustee"). Shortly after its appointment, the Trustee disclaimed the Tenant's lease. Pursuant to the terms of its lease, the Tenant had arranged for a $2.5 million letter of credit to be issued by a bank and provided to the Landlord, as beneficiary under the letter of credit (the "LC"). The LC was backed by an equal amount of cash collateral held by the bank. The lease and the terms of the LC specifically stipulated that the LC was to stand as security for any losses, costs or damages of the Landlord arising from the Tenant's failure to perform its obligations under the lease or resulting from the termination, surrender, disclaimer or repudiation of the lease in connection with an insolvency or bankruptcy proceeding of the Tenant. The LC was in good standing at the time the lease was disclaimed. The Landlord drew upon the LC, both before and after the disclaimer, and in the process drew down the full amount of the $2.5 million LC.

The Trustee brought a motion to determine the Landlord's entitlement to draw upon the LC. The lower court judge decided that the Landlord's allowable draw on the LC was limited to the amount of its three-months'...