Can a receiver partially disclaim a lease?

One of the tools available to a receiver is the power to affirm or disclaim contracts.  Paragraph 3 of the commercial list users committee model receivership order sets out the powers generally given to a receiver appointed pursuant to section 243(1) of the Bankruptcy and Insolvency Act and section 101 of the Courts of Justice Act.  Subparagraph 3(c) includes the power to cease to perform any contracts of the Debtor. 

The power given to a receiver pursuant to subparagraph 3(c) of the model order includes the power to affirm or disclaim an equipment lease or a master lease for various pieces of equipment.  The receiver can affirm the lease, continue making lease payments and continue using the equipment or the receiver can disclaim the lease, return the equipment and stop making the lease payments.

But what happens if the receiver needs some, but not all, of the equipment leased pursuant to a master lease?  Can a receiver disclaim part of the lease?  And if the receiver does this, how are the lease payments calculated?

This issue was recently considered by the Honourable Justice Duncan in Yukon (Government of) v. Yukon Zinc Corporation, 2020 YKSC 16 (“Yukon”). 

In Yukon, a receiver was appointed over a flooded and deteriorating mine which was no longer operational.  The receiver’s mandate was to stabilize the mine but not to operate it as a going concern.

Yukon Zinc Corporation (the “debtor”), which operated the mine, leased 572 pieces of equipment (the “Leased Equipment”) from Welichem Research General Partnership (“Welichem”) pursuant to a sale and leaseback transaction.  The debtor entered into a master lease with Welichem for the 572 pieces of Leased Equipment.  The Leased Equipment included tools, vehicles and infrastructure at the mine.  The master lease required monthly lease payments in the amount of $110,000.

The receiver took possession of the mine and identified 79 of the 572 pieces of Leased Equipment that were essential for the continuing and necessary care and maintenance and environmental remediation of the mine (the “Essential Items”).  The Essential Items included various vehicles, trailers for staff accommodations, a water treatment plant, various tanks, generators, graders, excavators, and other items of machinery.  The receiver incurred over $200,000 to repair the Essential Items to a workable operating standard.

The receiver spent several months negotiating with Welichem to lease just the Essential Items.  When the negotiations failed the receiver issued a notice of partial disclaimer which provided that the receiver intended to disclaim the master lease but was preserving its right to use the Essential Items for a monthly payment of $13,500. 

Welichem brought an application to the court to set aside the partial disclaimer and for an order that the receiver affirmed the master lease and was required to make the full lease payments in the amount of $110,000 per month.

Welichem raised four arguments against the receiver’s power to partially disclaim the master lease:

  1. at law the receiver has a binary choice – affirm the entire master lease or disclaim the entire master lease;
  2. the partial disclaimer was an attempt to unilaterally alter the material terms of the master lease;
  3. the BIA does not include the ability to disregard property and civil rights which in this case was Welichem’s ownership of the Leased Equipment;
  4. the court’s inherent jurisdiction does not allow it to alter the master lease.

The receiver acknowledged that generally a contract is declaimed in its entirely however there is no legal authority prohibiting a partial disclaimer.  The receiver argued that:

  1. the receivership order had several provisions authorizing the partial disclaimer;
  2. the powers granted to the receiver pursuant to s. 243 of the BIA and section 26 of the Yukon Judicature Act were broad enough to include the partial disclaimer; and
  3. the court has discretion provided by s. 243 of the BIA and its judicial interpretation to allow the partial disclaimer;

The receiver also relied on the statement in Bennett on Receiverships that “in the proper case, the receiver may move before the court for an order to breach or vary an onerous contract including a lease of premises or equipment”.

Justice Duncan concluded that the receiver did have the authority to partially disclaim the master lease. 

The receiver could retain the Essential Items and make monthly lease payments in the amount of $13,500.

Generally when deciding whether to disclaim a lease the receiver has to consider whether there can be a higher realization for creditors by performing the contract while keeping in mind that if a contract is not disclaimed, the party seeking to uphold it would receive a significant preference not available to other creditors. 

When considering whether the receiver has the power to partially disclaim a lease, Justice Duncan considered the order appointing the receiver and the legislation under which the receiver was appointed.

First Justice Duncan considered the order appointing the receiver. 

Subparagraph 3(c) of the order appointing the receiver gave the receiver the power to cease to perform any contracts of the debtor.  While this suggests that the receiver has a binary choice (as argued by Welichem) the subparagraph has to be read together with other paragraphs in the order which give the receiver the general authority to take steps reasonably incidental to its powers and statutory obligations, the power to undertake environmental and worker’s health and safety assessments, and the power obtain any regulatory approvals or permits it considers appropriate or necessary.  The receiver is also given the power to cease to carry on all or part of the business of the debtor.

In this case the debtor’s business was the operation of a mine.  The receiver was not carrying on this business.  The receiver was carrying on the care and maintenance and remediation in order to preserve the assets and allow the mine to become operation at a future time.

The Leased Equipment was needed by the debtor to carry on the business of operating the mine.  The Essential Items are the specific items identified by the receiver in order for it to carry on the work it is required to do – i.e. care and maintenance and environmental remediation.  In order to carry out its mandate under the appointment order, the receiver had to have the power to partially disclaim the master lease in order to keep only the Essential Items which were required for the care and maintenance and environmental remediation of the mine.

Next Justice Duncan considered whether the BIA permitted the receiver to use the Essential Items and the Court’s authority to permit this. 

The Court’s authority to grant the receiver powers is found primarily in subsection 243(1) of the BIA which says that the Court may appoint a receiver to take possession of a debtor’s property, exercise any control over the property, and, most importantly, take any other action that the court considers advisable.  This broad language permits the court to do not only what justice dictates but also what practicality demands. 

In interpreting subsection 243(1) it is important to bear in mind the purpose of receiverships generally.  The receiver’s primary task is to ensure that the highest value is received for the assets so as to maximize the return to the creditors.  Certainty of equitable distribution of the debtors’ assets among creditors is also important.  Further, the assets of an insolvent business must be managed responsibly, in compliance with regulatory requirements, in order to preserve the assets, preserve the reputation of the insolvent and to maximize value for creditors.

Justice Duncan remarked that solutions to BIA issues require judges to consider the realities of commerce and business efficacy. 

Welichem argued that the receiver’s actions were an incursion on its property and civil rights and that it was prejudiced by the receiver’s attempt to retain the benefits of the master lease without the obligations. 

Justice Duncan did not accept this argument.  The receiver paid and continues to pay Welichem monthly for using the Essential Items.  It invested $200,000 in repairs to bring the equipment to operational standards.  The receiver is required to act to benefit all creditors, not just Welichem, in preserving the debtor’s assets by carrying on the necessary care and maintenance and environmental remediation of the mine. 

In this case, the pragmatic problem-solving approach is to allow the receiver to use the Essential Items in order to ensure the care and maintenance and environmental remediation of the mine can continue. 

For these reasons Justice Duncan found that there is authority under paragraph 243(1)(c) of the BIA for the Court to allow the receiver to use the Essential Items for the purpose of carrying out the necessary care and maintenance and environmental remediation.

The receiver calculated the $13,500 per month cost for the Essential Items on the basis of their percentage of the 572 items leased pursuant to the master lease as well as the percentage of their value based on an appraisal.  Justice Duncan accepted this as a reasonable amount for the Essential Items.

Going forward the Court will still have to give receivers guidance on when a lease can be partially disclaimed and what the new lease payments should be.

Justice Duncan thoroughly analyzes the order appointing a receiver, the relevant sections of the BIA, and the caselaw regarding disclaiming leases.  The power to partially disclaim a lease will give receivers much needed flexibility when dealing with the practicalities of administering an estate. 

However further judicial guidance is needed for receivers and lenders to know when a partial disclaimer is available and should be used.  It may be that this has to be a fact specific analysis.  This will definitely depend on the nature of the leased assets, the debtors business, the receiver’s mandate and the location of the assets.  The court may also consider the identity of the lessor and the lessor’s ability to re-lease or sell the remaining assets. 

While Justice Duncan spends significant time on whether the receiver is able to partially disclaim the lease and whether the receiver requires the Essential Items to perform certain duties, very little time is spent on the potential prejudice to Welichem. 

For example, the receiver arrived at its price based on the number of items it retained compared to the total and based on an appraisal.  However is the price fair?  The master lease was for 572 items while the receiver was only retaining 79.  Did Welichem offer the debtor a discount because 572 items were leased which the receiver was taking advantage of while only leasing a fraction of the items?  The monthly lease payment to be paid by the receiver did take into account the appraised value of the Essential Items compared to the total value of the Leased Equipment however there was no consideration of how quickly the Essential Items would deteriorate compared to all the Leased Items or whether the price should be higher because the items are more difficult to lease. 

Yukon is a very receiver-friendly decision, both in terms of giving the receiver the power to partially disclaim a lease and in terms of giving the receiver broad discretion to arrive at what is a fair payment for items that are not disclaimed.  The right to partially disclaim is likely to remain.  It is a useful tool for a receiver, if used properly.  However it is likely that subsequent decisions will place greater controls on when leases can be partially disclaimed and how the new lease payments are calculated.

KMB Law acts for lenders and court appointed receivers to negotiate, and if necessary litigate, disclaimers of leases or any other enforcement matters.  If you’re a receiver considering partially disclaiming a lease or a lender facing the prospect of having a lease partially disclaimed contact Wojtek Jaskiewicz at wjaskiewicz@kmblaw.com or visit our website at www.kmblaw.com

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