The Ontario Court of Appeal has overturned a decision of a lower court and found that a letter of credit (L/C) issued by a third-party lender as security for a tenant's obligations under a lease must be honoured in full, even in the event of a tenant becoming bankrupt.

While this case does not involve a tenant bankrupted by the impact of the coronavirus pandemic, a rise in legal actions as result of tenants forced out of business by the crisis is anticipated, and commercial landlords are bracing themselves for legal actions challenging the legitimacy of L/Cs put up to guarantee tenants' obligations under a lease.

Decision overturned

In this case a lower court decision found that when the tenant became bankrupt, its landlord was entitled to just three months' rent, even if its actual damages were much higher. This prevented the landlord from drawing any amount more than three months' rent, even though the L/C was for a much higher amount.

The court of appeal overturned the lower court ruling, finding that the landlord was entitled to draw on the L/C to the extent of the landlord's losses resulting from the termination or surrender of the lease.

Autonomous L/C principle

The higher court based its decision on the autonomy principle for L/Cs so the issuing bank is obliged to honour a draft on a credit that is independent of the performance of the underlying contract for which the credit was issued, subject only to the fraud exception.

The court of appeal found there is no principle of insolvency law that trumps the landlord's rights as the L/C beneficiary.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.