Is a landlord entitled to draw on a letter of credit if a lease is disclaimed by a trustee?
The Respondent Tenant leased an industrial building from the Appellant Landlord. Pursuant to the terms of the lease, the Tenant had put in place a $2.5 million letter of credit (LOC) in favour of the Landlord as beneficiary. The tenant made an assignment in bankruptcy in May 2018. The trustee disclaimed the lease in July 2018. Following the assignment in bankruptcy, the Landlord made three draws on the LOC, both before and after the trustee’s disclaimer of the lease, for the full amount of the $2.5 million credit.
On a motion brought by the Trustee, the motion judge determined that the Landlord was only entitled to draw on the LOC to recover the amount of its preferred claim for three months’ accelerated rent under s. 136(1)(f) of the Bankruptcy and Insolvency Act. The Landlord appealed from the decision, arguing that the obligations created by the LOC between the issuer bank and itself as the beneficiary were not affected by the Trustee’s disclaimer of the lease.
The Ontario Court of Appeal commenced its analysis by noting that the LOC is a standby letter of credit, which consists of an undertaking by the issuing bank to honour drafts or other demands for payment by the beneficiary upon compliance with the conditions specified in the credit. A fundamental characteristic of standby letters of credit is their autonomy from the underlying transaction between the applicant and the beneficiary. When the documents specified under a letter of credit are delivered to an issuing bank, the bank must examine the “presentation” to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a “complying presentation”. If they do, the bank must honour the draft.
The agreement between the Landlord and Tenant was that the rights of the Landlord under the Lease in respect of the LOC would continue in full force and effect in the event of the Tenant’s bankruptcy as if the Lease had not been disclaimed. The terms of the Lease and LOC clearly gave the Landlord the right to draw on the LOC for losses arising from the disclaimer of the Lease in the Tenant’s bankruptcy proceeding. The Landlord presented such drafts and the bank honoured them as complying presentations.
The Trustee argued that when it disclaimed the Lease, the Landlord was precluded by the operation of insolvency law from drawing on the LOC for any amount in excess of the Landlord’s preferred claim for three months’ accelerated rent. The Trustee submitted that such a principle of insolvency law overrode the autonomy principle for LOCs.
The Court of Appeal affirmed the autonomy principle. But for the limited exception of fraud, an issuer must pay the beneficiary upon receiving proper certification. The conduct of the Landlord in this case did not fall within the fraud exception so as to constrain the application of the autonomy principle and limit the Landlord’s ability to draw on the LOC. The statements by the Landlord in the certificates it presented to the bank were not “clearly untrue or false” when assessed in the context of the underlying contract (the Lease) between the beneficiary (the Landlord) and the applicant (the Tenant). The record did not contain any evidence that the Landlord acted with impropriety, dishonesty, or deceit.
Second, the Court confirmed that a landlord’s entitlement to draw on a letter of credit in a given case will turn on the particular language of the lease and letter of credit. In the present case, the Lease specifically provided that the LOC acted as security for indemnification of the Landlord for losses resulting from the Tenant’s insolvency or bankruptcy, and that the Landlord’s rights in respect of the LOC were not affected by the disclaimer of the Lease in any bankruptcy proceeding.
Accepting the Trustee’s position would mean accepting that the BIA does not permit a landlord to take security from its tenant—through the vehicle of a letter of credit—that would exceed the amount of a claim for accelerated rent under BIA s. 136(1)(f). The BIA does not contain any such language of limitation or prohibition that overrides the principle of autonomy. Therefore, nothing precluded the Landlord from drawing on the LOC for amounts in excess of its preferred claim against the bankrupt’s estate for three months’ accelerated rent.
The Court allowed the appeal and set aside the order of the motion judge.
Counsel: John Finnigan, D.J. Miller and Scott McGrath of Thornton Grout Finnigan LLP for the Appellant and Harvey Chaiton and Sam Rappos of Chaitons LLP for the Respondent.
Judges: Brown, Paciocco and Nordheimer JJ.A.