Securities & Remedies Related to Leases

Overview

When a lessor enters into a commercial lease (bail commercial), the risk of non-payment sits at the centre of the transaction. The Civil Code of Quebec (Code civil du Québec, or CCQ) provides several tools for the lessor to secure the tenant's obligations, and separately allows the lessor to pledge future rental income to its own creditors. This article surveys both sides of that equation: the securities (sûretés) a lessor may demand from a lessee, and the hypothec (hypothèque) on rents that a lessor may grant to a third-party lender. It also addresses the remedies available when a lease is granted in fraud of a creditor's rights, including the application of the broader principle that fraud corrupts all (la fraude corrompt tout).

Learning Objectives

After reading this lesson, the reader should be able to:

Identify the main security devices available to a commercial lessor under Quebec law and explain why the former statutory privilege no longer exists
Explain the limited practical value of a movable hypothec on furnishings, particularly in the context of bankruptcy
Describe the function and limits of suretyship in the lease context, including the effect of lease renewal on the surety's obligation
Outline how a standby letter of credit operates as lease security and what drafting precautions apply
Distinguish between a hypothec on rents as a real right and the limited administrative role of the hypothecary creditor who collects rents
Recognize when a Paulian action or the fraud-corrupts-all principle may be invoked to set aside a lease granted in fraud of creditor rights

Key Concepts and Definitions

Security (sûreté): A right granted to a creditor over property, or by a third party's undertaking, that reinforces the likelihood of payment. Securities may be personal (such as suretyship) or real (such as hypothecs).

Hypothec (hypothèque): A real right charged on movable or immovable property to secure the performance of an obligation. It confers on its holder a right of preference and, in some cases, a right to follow the property into the hands of subsequent acquirers.

Suretyship (cautionnement): A contract by which a person, the surety (caution), obligates himself towards the creditor to perform the debtor's obligation if the debtor fails to do so.

Pledge (gage): A movable hypothec with delivery, created by the physical transfer of property to the creditor or, in the case of money, by remitting the funds.

Letter of credit (lettre de crédit): An irrevocable undertaking by a financial institution to pay the beneficiary upon presentation of specified documents during the period of validity.

Paulian action (action en inopposabilité): A remedy allowing a creditor to have declared unenforceable against him a juridical act made by the debtor in fraud of the creditor's rights (art. 1631 CCQ).

Priority (priorité): A right of preference granted by law rather than by agreement, ranking ahead of hypothecs (art. 2651 CCQ).

Securities Available to the Lessor

A commercial lessor faces the constant risk that a tenant will default on rent or other lease obligations. Unlike residential tenancies, where regulatory protections limit the types of security a landlord may require, commercial leases permit the parties considerable contractual freedom. Quebec law offers several mechanisms for the lessor to reduce credit risk, though each carries distinct limitations that practitioners must account for in the drafting process.

The Historical Privilege and the Obligation to Furnish

Under the former Civil Code of Lower Canada (Code civil du Bas-Canada), the lessor of non-residential premises held a statutory privilege (privilège) over the movable property found on the leased premises and belonging to the lessee (art. 1637 to 1640 C.c.B.-C.). This privilege functioned similarly to the priorities (priorités) now set out in art. 2651 CCQ, giving the lessor a preferential claim on the tenant's assets located in the premises without the need for any contractual stipulation.

The Civil Code of Quebec did not reproduce these provisions. The privilege disappeared when the new Code came into force on January 1, 1994.

The obligation to furnish the premises (obligation de garnir les lieux loués) followed a parallel path. It had already been removed from the Civil Code of Lower Canada during the 1973 reform and was not revived in the CCQ. The Superior Court (Cour supérieure) confirmed this position in Dubord c. Gestions Malipa Inc., where Justice Macerola held that, absent a statutory provision creating or maintaining the obligation, a lessor cannot compel the lessee to furnish the premises by operation of law alone.

The practical consequence is direct: if a commercial lessor wants the premises to contain movable property against which it can assert a claim, it must include an express contractual obligation to furnish in the lease itself, or negotiate a conventional movable hypothec under art. 2684 CCQ.

Movable Hypothec on Furnishings

A lessor may require the lessee to grant a conventional movable hypothec (hypothèque mobilière conventionnelle) over the movables kept on the premises. While this mechanism is available, its practical utility is limited for several reasons.

First, the liquidation value of office furniture, fixtures, and equipment is generally low, particularly in a forced-sale context. The costs of exercising a hypothecary recourse, including legal fees, publication fees, and the expenses of seizure and sale, may approach or exceed the proceeds of realization.

Second, and more significantly, bankruptcy renders the hypothec largely ineffective. In Faillite de Restaurant Ocean Drive Inc. et Canpro Investments Inc., the Quebec Court of Appeal (Cour d'appel) held that where the lessee becomes bankrupt, the lessor who is also a hypothecary creditor on the furnishings cannot exercise its hypothecary rights independently. The Bankruptcy and Insolvency Act (BIA) takes precedence, and the trustee in bankruptcy controls the realization process.

This ruling remains a leading authority in the field of commercial lease securities. It means that, in the very scenario where security matters most, the movable hypothec on furnishings provides the lessor no separate path to recovery outside the bankruptcy distribution.

Bankruptcy Priority for Unpaid Rent

Although the movable hypothec offers limited protection in bankruptcy, the lessor retains a statutory priority under federal insolvency law. Section 136(1)(f) of the Bankruptcy and Insolvency Act grants the lessor a preferred claim, exercisable against the proceeds of realization of property located on the leased premises, for:

Arrears of rent for the three months preceding the bankruptcy
Accelerated rent, if the lease so provides, up to a maximum of three additional months of rent

This priority exists by operation of law and does not require the lessor to hold any hypothec or other contractual security. For this reason, a contractual clause requiring the lessee to furnish and maintain property on the premises retains value even when the hypothec itself would fail in bankruptcy: the more property found on the premises at the date of bankruptcy, the larger the pool against which the statutory priority may be exercised.

Security Deposits and the Pledge

In commercial leasing, the lessor may require the lessee to provide a cash security deposit (dépôt de garantie). The legal characterization of such deposits raises a distinct issue when the lessee enters bankruptcy.

In a decision following the principles established in Faillite de Restaurant Ocean Drive Inc., Justice Clément Gascon of the Superior Court ordered a lessor to remit to the trustee in bankruptcy a security deposit received under a lease. The court held that the deposit constituted a movable hypothec with delivery, also called a pledge (gage), and that the Ocean Drive principles therefore applied. Because hypothecary rights are subordinated to the bankruptcy process, the deposit had to be returned to the estate for distribution to creditors generally.

This characterization creates a practical trap for lessors who assume that holding a cash deposit gives them a priority claim outside the bankruptcy distribution. In practice, any monetary deposit held by the lessor may be treated as a pledge and therefore subject to the same limitations as any other hypothecary right once the lessee is declared bankrupt.

Consider a scenario: a commercial lessor holds a $50,000 security deposit from a lessee who subsequently becomes bankrupt. Rather than applying the deposit to the unpaid rent, the lessor may find itself compelled to remit the full amount to the trustee. The lessor's recovery would then be limited to the statutory priority under the BIA, which may yield far less than the amount of the deposit.

Suretyship

Suretyship (cautionnement) is a personal security by which a third party obliges itself to perform the lessee's obligations if the lessee defaults. Lessors of commercial premises regularly require the personal guarantee of a controlling shareholder or a related corporate entity.

Quebec law imposes specific limits on suretyship in the lease context. Under art. 1881 CCQ, a security granted by a third party to guarantee the performance of the lessee's obligations does not extend to a renewed lease (bail reconduit). If the lease is renewed, whether by tacit reconduction or by the exercise of a renewal option, the surety's obligation does not carry over unless the suretyship contract expressly provides for it. A lessor who fails to address this point in the drafting stage may discover that the personal guarantee, which appeared to cover the entire lease relationship, terminated at the end of the initial term.

The scope of the suretyship must also be stated with precision. A guarantee limited "to the guarantee of rent" (à la garantie du loyer) covers only the rent obligation. It does not secure the lessee's other covenants, such as obligations to maintain the premises, pay for common area expenses, or comply with use restrictions. Lessors who want broad coverage should ensure that the suretyship expressly extends to all of the lessee's obligations under the lease.

In residential leasing, an additional constraint applies: no guarantee may be required on a discriminatory basis. This prohibition reflects the broader human rights protections governing residential tenancies.

Consider a scenario: a lessor leases commercial premises with a five-year initial term and one five-year renewal option. The controlling shareholder of the lessee signs a personal suretyship for "all obligations of the lessee." If the lease is renewed for the second five-year term, the surety's obligation ceases unless the suretyship agreement expressly extends to the renewal period under art. 1881 CCQ.

Letters of Credit and Guarantee

In non-residential leasing, an increasingly common form of security is the irrevocable standby letter of credit (lettre de crédit standby) or irrevocable letter of guarantee (lettre de garantie irrévocable) issued by a financial institution.

A standby letter of credit is an irrevocable undertaking by a bank to pay a specified sum to the beneficiary upon presentation of certain documents during the period of validity. In a commercial lease context, the institution typically requires only a written declaration from the lessor stating that the lessee is in default under the lease terms.

The principal advantage of this instrument is its independence from the underlying lease relationship. The issuing institution is obligated to pay when the letter is duly presented, regardless of any dispute between the lessor and the lessee, except in a clear case of fraud. This independence principle makes the letter of credit one of the most reliable forms of lease security available.

The principal disadvantage is administrative complexity. Letters of credit are normally issued for limited periods, commonly twelve months at a time. The lease must require the lessee to renew the letter annually, for example thirty days before its expiry. If the lessee fails to renew on time, the lease should provide that this failure constitutes a default, allowing the lessor to draw on the existing letter before it expires. Without such a deemed-default clause, the lessor risks being left without security during a gap in coverage.

The letter of guarantee (lettre de garantie irrévocable) serves a similar function and is governed by comparable principles. Both instruments are typically subject to the International Standby Practices (ISP98, ICC Publication No. 590), which provide uniform rules on presentation and payment.

Financial institutions charge fees for issuing both types of instruments and typically require the lessee to provide counter-guarantees. These costs can be significant, though in some cases the institution may accept existing security over the lessee's assets. The letter itself must be drafted with care, and it is not always easy to convince the issuing institution to modify its standard form. Precision is particularly pressing when the lessee is at risk of bankruptcy, where the validity and enforceability of letters of credit and guarantee are commonly challenged.

Both instruments may include clauses permitting assignment or transfer to acquirers of the lessor's rights under the lease or to the lessor's hypothecary creditors, broadening the utility of the security beyond the original parties.

Hypothec on Rents: Securities Granted by the Lessor

The lessor may also use its stream of rental income as security for its own borrowing. When a lessor obtains financing, particularly for the acquisition or development of an immovable, lenders frequently require a hypothec on the rents (hypothèque sur les loyers) payable by the lessees. This section examines the nature, publication, and effects of such a hypothec.

Nature and Publication

Under the CCQ, a hypothec on rents derived from an immovable is deemed to be an immovable security by operation of law (art. 2695 CCQ). This classification applies regardless of the movable character of the underlying claim; the rents arising from an immovable property are treated as immovable for purposes of the hypothecary regime.

As an immovable hypothec, the security is published at the Land Register (Registre foncier) and takes rank according to the date and time of its registration (art. 2941 CCQ). This registration establishes the creditor's right of preference over the rents as against other creditors.

Where the rents arise from a movable property lease, the hypothec on the claim remains movable and is governed by art. 2710 to 2713 CCQ.

Opposability to the Lessee

A hypothec on rents from an immovable confers on the creditor the right to collect the rents from the moment of registration, even without any default by the lessor-debtor under the loan or deed of obligation (art. 2743 CCQ).

Although art. 2743 CCQ does not prescribe any specific formality to make the registration opposable to the lessee, Professor Denise Pratte has argued persuasively that the rules applicable to hypothecs on movable claims should apply by analogy (art. 1641 and art. 2710 to 2713 CCQ). Under this approach, the hypothecary creditor should notify the lessee of the hypothec before demanding direct payment.

This position reflects a practical necessity. If the lessee has not been informed of the hypothecary registration, the lessee cannot reasonably be expected to pay anyone other than the lessor. Payment made in good faith to the lessor in such circumstances would likely be liberatory under the rules governing payment to an apparent creditor (créancier apparent) set out in art. 1559 CCQ.

In residential tenancies, notice to the lessee is particularly appropriate. The lessee must be able to determine with certainty to whom rent is payable; otherwise, the lessee may apply to the Tribunal administratif du logement for authorization to deposit the rent (art. 1908 CCQ).

Authorization to Collect Rents and Its Withdrawal

In practice, the deed of loan typically authorizes the lessor to continue collecting rents even after the hypothec is registered. This arrangement is the norm: most lenders do not wish to manage individual rent collections so long as the borrower remains in good standing under the loan agreement.

The creditor retains the right to withdraw this authorization at any moment (art. 2744 CCQ). Such a withdrawal does not require cause and constitutes a unilateral act by the creditor. The withdrawal must be notified to both the lessee and the lessor and must be registered at the Land Register (art. 2745 CCQ; art. 132 and 133 of the Code of Civil Procedure).

Once the authorization is withdrawn, the lessee must direct rental payments to the hypothecary creditor. Any payment made to the lessor after proper notification of the withdrawal would not be liberatory.

The Hypothecary Creditor's Limited Role

Collecting rents does not make the hypothecary creditor a lessor. The creditor does not assume the lessor's obligations under the lease by virtue of receiving rental payments. The Superior Court affirmed this principle in a judicial review proceeding, refusing to recognize any right for the lessees to pursue the hypothecary creditor for the performance of the lessor's obligations, even where the creditor had taken certain administrative steps.

In Salon Au Carré Inc. c. 9353-6282 Québec Inc., Justice Nicole Tremblay made a careful distinction between the routine management acts a creditor may perform to protect the value of its security and the full assumption of a lessor's obligations. The court noted that in cases where the immovable is in poor condition, courts have permitted creditors to arrange essential repairs, hire cleaning personnel, and prepare leases. These acts are measures of simple administration (administration du bien d'autrui), proportionate to the complexity of the situation, and they do not transform the creditor into a lessor.

The Tribunal administratif du logement has, however, held that a hypothecary creditor who collects rent must account for compensation (compensation) under art. 1680 CCQ where the lessee holds a certain, liquid, and exigible claim against the lessor arising from a prior judgment. In that case, the creditor, as assignee of the rent claim, was required to reimburse the lessee for the compensable amount.

Right to Sue for Rent and Sign Leases

The hypothecary creditor may bring court proceedings to recover unpaid rents (art. 2746 CCQ). Courts have also recognized, on at least two occasions, that the hypothecary creditor may sign new leases as an act of conservation of the security, characterizing such acts as simple administration.

The Court of Quebec (Cour du Québec) has further recognized the creditor's right to seek resiliation (résiliation) of a lease for non-payment of rent, on the condition that the lessor is impleaded in the proceedings as a party whose rights may be affected (art. 184 and 188 of the Code of Civil Procedure).

The Paulian Action Against Fraudulent Leases

Where a lessor grants a lease in fraud of the rights of a creditor, the creditor may invoke the Paulian action (action en inopposabilité) under art. 1631 CCQ and following to have the lease declared unenforceable against it. The court may be called upon to determine the fair rental value (valeur locative) of the leased property and, where appropriate, order the eviction of the lessee.

Two significant decisions of the Tribunal administratif du logement, authored by Administrative Judge Jean-Claude Pothier, illustrate the reach of this remedy beyond its formal statutory boundaries. In both cases, a creditor had realized its hypothecary security and become the owner of the immovable. The new owner sought the eviction of lessees who held leases granted in fraud of the creditor's rights prior to the realization.

The respondents challenged the application of the Paulian action, arguing that art. 1631 CCQ applies only while the property remains in the debtor's patrimony (patrimoine). Since the creditor had already realized the security and taken ownership, the property was no longer in the original debtor's hands.

Judge Pothier rejected this narrow reading:

[...] it would be illogical to think that a remedy could exist before the realization of the security and not after; in equity and by analogy, such a narrow solution must be set aside. (TR)

The tribunal grounded its decision not on art. 1631 CCQ directly, but on the broader principle, better known in French law, that fraud corrupts all (la fraude corrompt tout). Through a thorough analysis of this rule and the supporting doctrine, the tribunal granted the new owners' applications for eviction.

This line of authority confirms that the protection against fraudulent leases extends beyond the formal boundaries of the Paulian action as codified. Where a lease is shown to have been granted with the intent to defraud a creditor, the courts retain the power to intervene even after the creditor has realized its security and acquired ownership of the immovable. For practitioners, this means that a creditor who discovers a fraudulent lease only at the stage of realization is not without recourse.

Case and Article Pointers

Statutes and Provisions

Art. 1559 CCQ: payment to an apparent creditor
Art. 1631 CCQ and following: Paulian action
Art. 1641 CCQ: assignment of claims
Art. 1680 CCQ: compensation and assignment
Art. 1881 CCQ: suretyship does not extend to renewed lease
Art. 1908 CCQ: deposit of rent by residential lessee
Art. 2651 CCQ: priorities
Art. 2684 CCQ: conventional movable hypothec
Art. 2695 CCQ: hypothec on immovable rents deemed immovable
Art. 2710 to 2713 CCQ: hypothec on claims
Art. 2743 CCQ: creditor's right to collect rents
Art. 2744 CCQ: authorization to continue collecting
Art. 2745 CCQ: withdrawal of authorization
Art. 2746 CCQ: suit to recover rents
Art. 2941 CCQ: rank by registration
Section 136(1)(f), Bankruptcy and Insolvency Act: lessor's priority

Judicial Decisions

Dubord c. Gestions Malipa Inc. (Superior Court): no obligation to furnish the premises absent a contractual or statutory provision
Faillite de Restaurant Ocean Drive Inc. et Canpro Investments Inc. (Quebec Court of Appeal): hypothecary rights on furnishings cannot be exercised independently in bankruptcy
Salon Au Carré Inc. c. 9353-6282 Québec Inc. (Superior Court): collecting rents does not make the hypothecary creditor a lessor

Practice Checklist

Include an express obligation to furnish the premises in any commercial lease where the lessor wants movable property available for realization
When taking a movable hypothec on furnishings, weigh realization costs against likely recovery, particularly in light of bankruptcy limitations under the Ocean Drive doctrine
Verify that any suretyship agreement covers renewal periods under art. 1881 CCQ and extends to the full scope of the lessee's obligations, not only rent
Draft standby letters of credit with precise default triggers and clear renewal provisions; include a deemed-default clause if the lessee fails to renew on time
Specify in the letter of credit or guarantee that the instrument remains valid and enforceable despite bankruptcy, insolvency, or resiliation of the lease
When holding a hypothec on rents, notify the lessee of the registration to ensure opposability and prevent liberatory payment to the lessor under art. 1559 CCQ
On withdrawal of the lessor's authorization to collect rents, serve formal notice on both the lessee and the lessor, and register the withdrawal at the Land Register under art. 2745 CCQ
Avoid assuming the role of lessor when exercising administrative acts as a hypothecary creditor; limit activities to measures of conservation and simple administration
Where a lease appears to have been granted in fraud of the creditor's rights, consider both the Paulian action under art. 1631 CCQ and the broader principle that fraud corrupts all

Glossary

Assignment of claim (cession de créance): The transfer of a creditor's right against a debtor to a third party.
Compensation (compensation): The extinguishment of reciprocal obligations between two persons up to the amount of the lesser obligation.
Hypothec (hypothèque): A real right charged on property to secure the performance of an obligation.
Land Register (Registre foncier): The public registry where rights in immovable property, including immovable hypothecs, are published.
Lease (bail / louage): A contract by which one party, the lessor, provides the other, the lessee, with the enjoyment of a thing for a determinate time in exchange for rent.
Letter of credit (lettre de crédit): An irrevocable undertaking by a financial institution to pay a beneficiary upon presentation of conforming documents.
Letter of guarantee (lettre de garantie irrévocable): A bank instrument functionally similar to a standby letter of credit, guaranteeing payment upon proof of default.
Paulian action (action en inopposabilité): A creditor's remedy to have a juridical act made in fraud of the creditor's rights declared unenforceable.
Pledge (gage): A movable hypothec with delivery of the property to the creditor.
Priority (priorité): A right of preference granted by law, ranking ahead of hypothecs.
Resiliation (résiliation): The judicial or contractual dissolution of a contract, effective from the date of dissolution rather than retroactively.
Security (sûreté): A right or undertaking reinforcing the likelihood that a creditor will be paid.
Security deposit (dépôt de garantie): A sum of money provided by the lessee to the lessor as security for the performance of lease obligations.
Suretyship (cautionnement): A contract by which a third party obligates itself to perform the debtor's obligation if the debtor defaults.

References

Civil Code of Quebec (Code civil du Québec), art. 1559, 1631 and following, 1641, 1680, 1881, 1908, 2651, 2684, 2695, 2710 to 2713, 2743, 2744, 2745, 2746, 2941
Bankruptcy and Insolvency Act, RSC 1985, c B-3, s 136(1)(f)
Code of Civil Procedure (Code de procédure civile), art. 132, 133, 184, 188
International Standby Practices (ISP98), ICC Publication No. 590
Dubord c. Gestions Malipa Inc. (Superior Court)
Faillite de Restaurant Ocean Drive Inc. et Canpro Investments Inc. (Quebec Court of Appeal)
Salon Au Carré Inc. c. 9353-6282 Québec Inc. (Superior Court)
Pratte, Denise, Les sûretés, on hypothecs on claims and rents

This article is provided for educational purposes and does not constitute legal advice. For guidance on a specific legal matter, consult a qualified Quebec lawyer.

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