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Law Times • November 3, 2008 FOCUS PAGE 11 Refreshed awareness for need to enhance tenant covenants BY GRETCHEN DRUMMIE Law Times n these turbulent econom- ic times there's a refreshed awareness of the need for due diligence when landlords enter into leases to confirm tenants are viable, a Toronto real estate specialist tells Law Times in an interview. And, I Enhancing the tenant covenant. Can it be done? Vukovich says the first step in a concern, it is "more so now because [if] we're at the end of the good times and tenants start defaulting on leases more than they have in the past, maybe there is something that should therefore be done go- ing forward or could have been done going backwards to have qualified the tenant better as somebody who was likely to stick around and pay the rent," says Natalie Vukovich a partner at Daoust Vukovich LLP. So, Law Times asked her: while that's always the process is to ascertain if the tenant is for real. She says "one of the few things that landlords of- ten surprisingly fail to do is verify even that the tenant they are do- ing a lease with exists; they take it on face value that the entity who signs the lease or the offer is a real legal entity, but quite often out find out later that they don't even exist." Thus homework is key. "There are generally credit checks being done by sophisti- cated landlords to confirm who they're dealing with and their track record," says Vukovich. The next step is to evaluate Natalie Vukovich says enhancing the tenant covenant is more important than ever in an economic downswing. "whether that entity is any good . . . No one has the crystal ball that can guarantee that some- body is going to 'be good' for that whole time, but there are things you can do to satisfy yourself," she says. That includes looking at financial statements, the track record, and contacting past landlords. Pretty much the only way to find out if a tenant is go- ing to be difficult is to "scrounge around in the business world for every scrap of information." Vukovich says landlords can't be "wowed" by a name. There might be some familiar letters in a name, but it could "be the weakest arm of that company that has no assets that is your tenant." Also, some tenants will put forward that they're "abc, a division of a big name" but "the division isn't a legal entity [so] what are they offering you; whose covenant is that?" She says all the history that can be amassed on a company is vital. Vukovich says the landlord's position is stronger these days thanks to a 2004 Supreme Court decision called Crystalline Invest- ments Ltd. v. Domgroup Ltd., in which some "troublesome" law was clarified, clearing the way to enhancing covenants. In Crystalline the court rejected the law spawned by the Ontario Court of Appeal's 1965 decision Cummer-Yonge Investments Ltd. v. Agnew-Surpass Shoe Stores Ltd., which said that after a bankruptcy lease disclaimer, a lease guarantee fell away as a secondary obligation (because the primary obligation that it supported had itself gone away). "So tenants didn't have much at stake when they offered up a guarantee, a letter of credit or a security interest because none of them was available as recourse after the company went bankrupt and the lease was dis- claimed," says Vukovich. "Crystalline however said that the continuing liability of an assignor was a primary ob- ligation, even though it's in the nature of a surety. It put an end to bubbling confusion about whether you could get at a letter of credit or any other backstop when it most mattered, i.e. after bankruptcy and disclaimer . . . [Until then] we were starting to think that there was absolutely no way that you could backstop a tenant's obligation." Vukovich adds there's been "some talk about whether what was said in Crystalline was obit- er and really doesn't have any weight . . . but everyone in the tenant's obligations; it's a vi- able covenant enhancement that didn't really have much favour over the last little while because it was so tenuous and questionable whether it would even work," she says. "Now we know it does work and I think that serious landlords should be looking to that as their best way to protect themselves." Vukovich suggests other tools like asking the tenant to pay all of the rent up front. While it's unlikely, it did happen recently in a deal she was involved in. "Lawyers are asked by their clients, 'What can I do,' as if they can some- how pull a rabbit out of the hat or be creative," she says. "There's not much creativity in play. There's the tenant's prom- ise to pay and there are ways to often being lords is therefore that they can write these things into leases now and can go after them," says Vukovich. While she isn't a big fan of the PPSA [Personal Property Security Act interest] she says landlords should try to get it in some cases. But Vukovich thinks the most reliable tool is the letter of credit. "If you are asking yourself, 'How am I go- ing to be sure that my tenant will perform,' put their feet to the fire and say, 'Please give me a letter of credit backstopping all of your rent obligations un- der the lease,'" she says. "It's a viable backstop to a commercial leasing industry has taken it as meaning that landlords can go after any type of backstop; all the backstops stand up after the tenant has gone into default, has gone bankrupt, and its trustee has disclaimed the lease. "The good news for land- support the tenant's promise. One is the security deposit, two is a security interest and three is a guarantor/indemnifier. Then, there is the letter of credit." Vukovich says lawyers should be trying to persuade their land- lord clients "to really try hard for the letter of credit. I think people stopped trying in all that time in the nineties when times were good and on the upswing. And, there was all this confusion in the law and it was just not worth trying to enhance the covenant in that way because you weren't sure what you were getting. "Now, you can get it. You see anything a few years ago, now you're sure they are worth a lot so ask for it. Push hard for it." Vukovich concedes the law- yers might "come across like they have three heads," to a doubting landlord, but "it is being done, there are some who are doing it so why aren't more doing it? It's the home run." She says on top of the let- you have troubled times ahead, so this is the time to start asking for letters of credit," she says. "If you weren't sure they were worth ter of credit, these days land- lords should go after as much as they can get, including the security deposit, one or more guarantors/indemnifiers, PPSA interest, or rent up front. "Lawyers should advise their clients to try and get all of those things because they are all likely to be enforceable more so than in the past," says Vukovich. LT For Real Estate Lawyers Only It's all here! Practice Resources Access the Resource Centre at www.lsuc.on.ca or phone 416-947-3315 or 1-800-668-7380 ext. 3315. Legal information and support designed for you. LawSociety_LT_Nov3_08.indd 1 www.lawtimesnews.com 10/27/08 11:29:14 AM Real Estate Practice Portal The new online Real Estate Practice Portal gives you easy and immediate access to the information important for your practice. The most popular resources and reference tools for the real estate practitioner have been compiled and placed in one place. 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