Cow Harbour True Lease Characterization Decision 'Released'

Generally speaking, if a lease is determined to be a “true” lease, then the lessor is entitled to be paid rent during the restructuring period and may not be subject to certain costs associated with the restructuring. Accordingly, the economic impact of not being a “true” lease can be a very significant difference in the recovery obtained. Historically, the determination also impacted whether leases had to be registered under the Personal Property Security Act (“PPSA”), but recent changes to the PPSA have made this debate a non-issue. Unfortunately, the statutes governing Canadian insolvency legislation simply utilize the word “lease” but do not provide for any commentary or direction as to the meaning of the term. Reliance is placed on the common law and the common law, not surprisingly, is unclear. To complicate matters, tax and accounting have different tests for “true” and “finance” leases that are not common law driven but rules based.

Lessors will often structure leases such that they will achieve the tax or accounting test for “true” leases, mistakenly thinking that they have achieved the same results for insolvency purposes. The accounting test under GAAP (as opposed to IFRS) is relatively black and white, focusing on residual value and who holds that risk. The legal test for insolvency purposes, however, does not use such a simplistic formulation, and as a result confusion and frustration in the industry has reigned. While the recent Cow Harbour discussion is helpful in reducing this frustration, it does not end it.