Canada: A Landlord's Right Of Distress – Subject To The Crown's (Super-Priority) Deemed Trust

Right of Distress

"Distress", when used in this context, means the seizure of someone's property to secure the performance of a duty. A landlord's right of distress is a useful self-help remedy that allows a landlord to enforce its rights against a delinquent tenant under certain circumstances. When performed properly, it allows the landlord to seize and sell the tenant's property for outstanding rental arrears in priority of (some) other creditors and generally without the need for court approval.  The remedy has been available for centuries and is now governed by statute in many jurisdictions.  In New Brunswick, commercial landlord-tenant relationships, including the right of distress, are governed by the Landlord and Tenant Act (1973).

Can/Should a Landlord Distrain?

Before exercising its right of distress, a landlord should take a few preliminary steps. First, a landlord should review the terms of the lease to ensure that there is not a specific waiver of the right of distress or any requirement to deliver the tenant notice or demand for rent. Any such notice or demand provisions would need to be followed.

Further, it is prudent for a landlord to conduct standard due diligence searches on the tenant to ascertain competing registered security interests against the tenant's property. These searches should include the Personal Property Security Act and Bank Act. A bank holding security under the Bank Act and a secured party with a registered purchase money security interest are two examples of creditors that would have priority over a landlord's right of distress.

If a landlord decides to exercise its right of distress, it needs to be mindful of the applicable restrictions and limitations in relation to same.1

Unfortunately, even after conducting due diligence searches and complying with the applicable restrictions and limitations in exercising its right of distress, a landlord may not necessarily be protected from future claims to the sale proceeds of a tenant's property. The Minister of National Revenue (the "Crown") may be entitled to the sale proceeds on the basis of a "deemed trust" imposed by operation of the Income Tax Act (Canada). The concept of a deemed trust is addressed below.

Deemed Trust in Favour of the Crown – Super-Priority

A "deemed trust" is triggered when an employer does not properly remit amounts collected or deducted for taxes or source deductions (e.g. employee income taxes, employment insurance, CPP contributions, and sales taxes from customers). The deemed trust attaches to the property of the debtor-employer to the extent of the amount of unremitted source deductions. This gives the Crown a type of super-priority in its claims for these amounts ahead of almost all other creditors, including a landlord.2

In Canada (Attorney General) v Community Expansion Inc. (2004), 5 CBR (5th) 210, the Ontario Superior Court of Justice addressed the issue of the Crown's deemed trust in the context of a landlord's distraint. In that case, the tenant had deducted amounts payable to its employees and failed to remit same to the Crown. This meant that the Crown had a deemed trust over the tenant's assets and proceeds therefrom. The tenant was also in default of its obligation to pay rent to its landlord.

The landlord exercised its right of distress and seized all of the tenant's assets and chattels. The landlord then sold the tenant's assets and chattels to a related entity, which in turn had them auctioned for sale to third party purchasers. The proceeds from the auction were the subject of this case. The Court was asked to determine the priority of the respective parties' claims to the proceeds. In order to do so, the Court considered whether the distraint by the landlord or the subsequent sales defeated the "deemed trust" entitlement of the Crown. Each transaction is addressed below.

  1. Assets and chattels in landlord's possession – The Court held (without reservation) that the Crown's deemed trust continued to apply to the assets and chattels when they were in the possession of the landlord following the exercise of distraint.
  2. Sale by landlord to related entity – The Court held that the deemed trust continued to apply to the assets and chattels in the hands of the initial purchasing entity (which was incorporated solely for the purpose of receiving these assets). Given the relationship between the landlord and the purchasing entity and the purpose for which the purchasing entity was incorporated, this sale could not be considered to be "in the ordinary course" nor a sale to third party purchasers at arm's length.
  3. Sale by related entity to genuine third parties – The Court held that the deemed trust was released by the subsequent sale to genuine third party purchasers but that the Crown's trust claim applied to the proceeds of the sale. The Court directed that all of the proceeds be paid to the Crown.

Reducing the Risk of a Deemed Trust Claim

As shown in Canada (Attorney General) v Community Expansion Inc., there is a risk that the Crown may have priority in relation to a tenant's assets or the proceeds arising therefrom based on a deemed trust.  While this case has received academic criticism, it was affirmed by the Ontario Court of Appeal and is currently good law. With that in mind, although a landlord cannot prevent the Crown from making a claim based on a deemed trust, it can take steps to determine whether such a claim exists and potentially avoid spending time and money selling a tenant's property.

Before proceeding too far into the distraint process, a landlord should notify the Canada Revenue Agency ("CRA") that it has seized the tenant's assets and that it intends to sell them. The landlord should ask CRA to advise whether there are any trust claims in respect of that tenant and to do so before the proposed sale date. If CRA responds and confirms the existence of trust claims, the landlord can assess whether to proceed based on the size of the claim, potentially saving itself time and money. Unfortunately, CRA is under no obligation to respond to such an inquiry.  If CRA does not respond, the landlord will need to decide whether it will proceed with the sale given the risk that the CRA could later demand that it be paid its portion of the proceeds. If the landlord decides to sell the tenant's assets, it should again notify CRA after the sale has been completed and inquire about any trust claims.

Takeaway

A landlord's right to distress is unique and can be an extremely useful remedy to deal with delinquent tenants. A prudent landlord will consider the potential risks involved and will take the time and steps necessary to protect its interests before acting.

Footnotes

1. Timing – a landlord may only exercise the right to distress the day following the day that rent becomes due and only between the hours of 8:00 am and 6:00 pm;

Reason for remedy – only available for recovery of rent arrears and not available for damages for breaches of other provisions of a lease;

Eligible goods – only certain goods may be distrained, including goods that are located upon the premises in respect of which the rent distrained for is due, that belong to the tenant, and in which the tenant has equity;

Must be reasonable – a landlord shall not distrain more goods than are reasonably sufficient to satisfy the rent arrears and the costs of distraint; and

Commercial tenancies only – In New Brunswick, the Residential Tenancies Act (1975) abolishes the remedy of distress for residential landlords (whether or not a right of distress had previously existed by contract of otherwise). Accordingly, residential landlords must enforce their rights through the Residential Tenancies Tribunal.

2. There are two exceptions to the Crown's super priority: these are the claims of unpaid suppliers of goods under section 81.1 and unpaid farmers, fishers and aquaculturists under section 81.2 under the Bankruptcy and Insolvency Act (1985) and security interests prescribed by regulation. The "prescribed security interest" is defined by Regulation, SOR 99/322 as a mortgage on land or a building where the mortgage is registered pursuant to the appropriate land registration system before the deemed trust arises.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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