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Navigating commercial tenancies amid COVID-19
April 17, 2020
Authored by RSM Canada LLP
Edwin P. Reilly, CPA, CA shared this article
Landlords and tenants should work together to address the fallout
INSIGHT ARTICLE |
As is the case with most industries over the past month, the commercial real estate landscape across Canada has quickly changed due to the impact of the COVID-19 pandemic. Landlords, tenants and other stakeholders face novel and unique challenges that require creative solutions in order to emerge from the other side of this pandemic in the best position possible.
Given the immediate and severe restrictions that have been put in place by various levels of government, landlords and tenants alike are scrambling to figure out a path forward. Landlords rely on rental income to meet their obligations, and rent is the biggest monthly expense for many, if not most, tenants. In this environment, all parties are focused on preserving cash and minimizing costs to survive.
There is no one-size-fits-all solution that will work for every business. However, communication, proactivity, creativity and flexibility are the key ingredients for stakeholders working through these uncertain times.
Informal restructuring and negotiations
The ideal first step is for landlords and tenants to negotiate in an effort to find a mutually acceptable compromise. Negotiation is not uncommon between landlords and tenants, and today’s COVID-19 environment has only exacerbated the need for such conversations.
In the past few weeks, as the pandemic has sent enormous shockwaves through the economy, some Canadian landlords, including real estate investment trusts (REIT), have taken actions to help commercial tenants. Here are some examples of changes businesses have implemented:
- Suspension of payments, also known as “rent holidays”
- Deferral of payments and adjustments to lease periods
- Renegotiation of lease terms, especially when a tenant has favorable or below-market rent
- Application of security deposits at a future date
According to a recent article from The Canadian Press and distributed by Bloomberg, a number of preeminent Canadian REITs have undertaken various initiatives in an effort to provide relief to their tenants, such as offering automatic 60-day interest-free rent deferrals, and committing to working with their tenants as needed.
From the tenant’s perspective, any negotiation should take into account the landlord’s profile (i.e., whether the landlord is an institution, private equity firm, shopping mall landlord, individual investor, etc.). Tenants should, where possible, also consider the landlord’s own financial circumstances, including its debt commitments.
Conversely, landlords need to be cognizant of the circumstances facing their tenants. Commercial activities have been limited as governments have designated businesses as either essential or nonessential. Nonessential businesses, such as movie theatres and fitness centers, have been ordered to close and, as a result, have lost most, if not all, of the revenue they would typically expect during the time frame of the closure. Some businesses that have been deemed essential, such as medical facilities and grocery stores, have not experienced a decrease in income; in fact, some may now be experiencing increased sales. Landlords need to be understanding of how government intervention has affected their tenants.
As a part of these discussions and negotiations, both parties will need to have a realistic and conservative view on the long-term outlook of the tenant’s business. Is the tenant’s business expected to bounce back after the pandemic? If so, when? Certain businesses will likely take longer to recover than others once the economy eventually returns to a more normal state. For example, many have predicted that the travel and tourism industry will suffer for a prolonged period, given consumers’ expected hesitancy to travel.
While landlords do not have the obligation or ability to bail out every tenant, it is certainly in their interest to negotiate with tenants to avoid having vacancies in their properties and incurring legal or other enforcement costs to terminate leases. For a landlord to protect the value of its property, it is essential to maintain a strong tenant base.
All agreements should be put in writing, to provide clarity for all parties involved.
Formal restructuring options
When negotiations fail or parties are at an impasse, individual landlords and tenants may find themselves in a situation where they need to think about a “Plan B,” which may involve considering formal restructuring options.
In Canada, there are two different pieces of legislation that allow debtors to restructure: the Bankruptcy and Insolvency Act (BIA), and the Companies’ Creditors Arrangement Act (CCAA).
Both acts provide debtors, including both landlords and tenants, with the mechanism to restructure their finances. Restructurings typically include compromising amounts owed to creditors and implementing a stay of proceedings that prevents creditors from commencing or continuing any action against them.
Here are some restructuring options available under the BIA and CCAA (Note that while bankruptcy is beyond the scope of this article, it may also be an inevitable conclusion, particularly for tenants unable to cope financially.)
A proposal is essentially a formal process by which a company (known as a debtor) sets out a plan for how it proposes to settle the amounts it owes to its creditors. Once a proposal is filed, proven creditors of the debtor can vote to either accept or reject the proposal. If the proposal is accepted by the majority of creditors holding at least two thirds of the value of the total claims voting on the proposal, the proposal is considered to be accepted, subject to Court approval. If the proposal is not accepted, the debtor is automatically deemed to have filed an assignment in bankruptcy.
Here are three primary benefits to making a BIA proposal:
- There is an automatic stay of proceedings. This prevents creditors, subject to certain exemptions, from commencing an action against a debtor for payment in arrears, and these creditors cannot continue any existing actions.
- The debtor has the ability to compromise its debts and reorganize its operations with a focus on having a viable business going forward.
- The debtor can disclaim contracts and agreements, including commercial leases, upon giving a 30-day notice to the other party.
If a landlord’s lease is disclaimed, it will have an unsecured claim against the debtor, and there is a specific formula in the BIA to quantify landlord claims to be included in the proposal.
The BIA proposal formula permits a landlord to file a claim for the lesser of:
- The aggregate of the rent for the first year following the date on which the disclaimer became effective and 15 per cent of the rent for the remainder of the term of the lease after that year; or
- Three years’ rent
Often, the result of this formula is that the landlord becomes the largest creditor of the debtor, and the debtor requires the landlord’s acceptance of the proposal in order for the restructuring to proceed.
In a proposal proceeding, tenants are not required to cure existing defaults or pay arrears at the commencement of the restructuring proceeding. However, tenants are obligated to pay post-filing rent for continued occupancy.
It is also important to note that a landlord cannot terminate or disclaim a lease, or sue the tenant for accelerated rent, once the tenant has filed a proposal or a notice of intention (NOI) to make a proposal.
While there are many similarities between the provisions for BIA proposals and CCAA restructurings, there are also a number of differences. Generally, the CCAA legislation tends to be more flexible in terms of timelines and possible restructuring terms.
As a general rule, restructurings under the CCAA are used by larger organizations, as the criteria for a debtor to commence restructuring proceedings under the CCAA requires that the debtor’s liabilities be in excess of $5 million of debt. The CCAA is the functional equivalent to Chapter 11 of the U.S. Bankruptcy Code.
Some of the key differences between the BIA and CCAA are:
- BIA proposals reflect a specific formula (as set out above) in calculating the amount offered to lessors, while the CCAA technically has no set criteria. Therefore, debtors are able to use different approaches in dealing with landlord claims under the CCAA.
- Under the BIA, there are stringent timelines related to filing an NOI or a proposal, convening a meeting of creditors, etc., that must be adhered to, whereas the CCAA allows for much more flexibility in this regard.
- If creditors vote to reject a proposal under the CCAA, the debtor is not automatically deemed bankrupt.
In summary, landlords and tenants should attempt to work toward a solution that works for both parties. In the event the parties cannot come to an agreement, the formal restructuring options described above may merit consideration.
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This article was written by Bryan A. Tannenbaum, Jeff Berger and originally appeared on 2020-04-17 RSM Canada, and is available online at https://rsmcanada.com/our-insights/coronavirus-resource-center/real-estate-and-covid-19-disruptions.html.
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