Insolvent Tenants: Are Model Receivership Orders Unfair To Landlords? What Landlords and their Advisors Need to Know

This article first appeared in Canadian Property Management
(Toronto: MediaEdge Communications Inc., October, 2009)

Linen N Things. Petcetera. A & B Sound. The commercial leasing landscape has been rocked recently by business failures that have left employees jobless and suppliers holding the bag. At the top of the list of victims are landlords, who have been left to deal with unpaid rent arrears and the challenge of finding acceptable replacement tenants.

Aside from the damage caused by a tenant’s insolvency, the insolvency process can victimize commercial landlords all over again. In a receivership, the receiver focuses on maximizing recovery for the secured creditor. In a bankruptcy, the trustee focuses on maximizing recovery for the general creditors. In either case, the process can leave landlords with little meaningful input, despite usually being among the most significant stakeholders.

Model Receivership Orders

Case in point: the model receivership orders now in place in a number of provinces. In a court-ordered receivership, the order appointing the receiver will typically go on for a dozen pages or more, and most of those pages are taken up with more or less standard clauses. Until the model receivership orders were introduced, these clauses would vary in their wording and precise effect, depending on which law firm’s precedent was being used.

Model receivership orders grew out of a desire to standardize receivership orders, so that time and energy could be focused on new or contentious aspects of the order sought. Beginning in Ontario, a committee of judges, lawyers and professional receivers worked to create a model order, with the intent that it would become the standard starting point for receivership orders, subject to the specific requirements of any particular case. This model order has now been adopted, with some changes, in British Columbia, Alberta and Saskatchewan.

Although this model order was never intended to be applied blindly to every receivership, the tendency sometimes is to use the model order as a “one size fits all” solution, regardless of the peculiarities of the particular case.

Unfortunately the model order was not drafted with the situation of an insolvent tenant in mind, and as a result it gives short shrift to the interests of commercial landlords. Here are some examples.

Receivership over Uncharged Leasehold Interests

In most commercial leases, the tenant cannot mortgage or charge its leasehold interest without the consent of the landlord. If no such consent is given, no charge granted by the tenant has any effect. Since most receivers are appointed under security granted to a bank or other secured creditor, the receiver’s powers should be limited to the assets covered by that security. In most cases this will NOT include the debtor’s interest as tenant under a lease, because of the no-charge covenant in most leases.

Despite this, the model receivership order authorizes the receiver to take possession and control of ALL the property of the debtor/tenant, even leasehold interests. This provision, if not challenged, allows a receiver to take control of the leased premises, even without the landlord’s consent.

Receiver’s Charge over the Lease

The model order also creates a charge in favour of the receiver to secure payment of their fees and disbursements (including their lawyer’s accounts). Again, this charge is over all of the debtor’s property, and is in priority to any other interests in the debtor’s property. Where the debtor is a tenant under a commercial lease, this provision gives the receiver a charge on the lease, even if the lease itself specifically prohibits any charge without the landlord’s consent.

Liquidation Sales

Controlling the use of premises is a key concern for commercial landlords, especially retail landlords who search for the right mix and “image” in their retail locations. “Liquidation”, “receivership” or “bankruptcy” sales are generally prohibited by the terms of the lease, because of the poor impressions such sales can create for the location as a whole.

The model receivership order allows the receiver to sell the property of the debtor/tenant without any restrictions as to the type of sale and without input from any landlord. The order usually provides that any single sale over a fixed amount requires further court approval, but ongoing sales below that threshold do not. In the case of a retail business, a receivership or liquidation sale from the leased premises would not require approval of the court or the landlord.

Keys and Security Codes

Another standard provision in the model order authorizes the receiver to change the locks and security codes for any premises in which the debtor has an interest, but does not require the receiver to give the new keys or codes to the landlord in the case of leased premises. This will be unacceptable to most landlords, if only for security and fire safety reasons.

Improving the Model Order

The solution for landlords is to press for changes to the model order to ensure that it better recognizes landlord’s rights. On the positive side, since the model orders are standard-form documents, it is possible to anticipate ahead of time what changes are needed, and to be ready to press for such changes.

As an example, the provision in the order that grants the receiver authority over all the debtor’s assets should be pared down, and should instead grant authority over only those assets covered by the security which is the subject of the receivership. In most cases, this will result in the debtor’s leasehold interest being excluded from the receivership.

Time of the Essence

Receivership applications are often brought before the courts on an urgent basis. It is by no means uncommon for a court application to be served one afternoon and heard the next morning. When landlords become aware of a pending receivership application, there is no time to lose in pushing for changes to the receivership order. Although it is possible to come back to court to ask for changes to an order that has already been granted, this is often an uphill battle, particularly where the receiver and others have already begun acting in reliance on the original order. To obtain the changes necessary to properly protect landlords, the time to strike is at the initial court application.

Landlords and their counsel need to be aware of the ways in which the model order shortchanges landlords, and need to be ready to push for changes to the model order as soon as possible.

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