In a decision handed down earlier today, in Willmott Growers Group Inc v Willmott Forests Limited (Receivers and Managers appointed) (in liquidation) [2013] HCA 51,  the majority of the High Court upheld the Victorian Court of Appeal’s conclusion that the liquidators of an insolvent landlord can disclaim a lease, thereby extinguishing the tenant’s leasehold interest.

This decision has clarified the situation for liquidators: leases can be disclaimed with full effect, so that the land can be sold or dealt with unencumbered by the tenant’s interest.  However it raises some difficult questions for tenants, particularly tenants with long-term leases, as it reduces certainty if the lease can later be disclaimed and it may also affect the ability of a tenant to raise finance using a long-term lease as security. 
 
In most instances, it will be more beneficial for the landlord’s creditors for the liquidator to sell/deal with the land on a ‘subject to lease’ basis: but where it is not, then tenants are at risk of having their leases extinguished.   A tenant can challenge the disclaimer in Court, but if this is not successful, their only remedy is to be treated as a creditor in the liquidation for the losses arising as a result of the disclaimer.
 
Background
 
Willmott Forests Limited (“WFL”) is the responsible entity and/or manager of a collection of managed investment schemes (“MIS”).  This case concerned forestry operations conducted on land owned by WFL, where WFL leased that land to investors in the MIS (“Growers”) and the Growers had the right to grow and harvest trees on that land.
 
WFL went into voluntary administration and receivers were appointed in September 2010, and liquidators were appointed in March 2011.  In conjunction with the receivers, WFL’s liquidators sought to sell WFL’s assets, including the land.  Ultimately, sale contracts were entered into for the sale of WFL’s land, on terms which included that the land had to be transferred free from the encumbrances arising out of the MIS (including the Growers’ leases). 
 
The liquidators sought directions, under s 511 of the Corporations Act 2001 (Cth) (“Corporations Act”), including directions approving the disclaimer of the Growers’ leases pursuant to s 568(1) of the Corporations Act with the effect of extinguishing the Growers’ leasehold interests.  Two groups of Growers acted as contradictors in those proceedings.
 
The Corporations Act allows liquidators to disclaim certain property of the company, including property consisting of a contract, such that the disclaimer is taken to terminate (from the effective date of the disclaimer) the company’s rights, interests, liabilities and property in or in respect of the disclaimed property.  Except for an unprofitable contract or a lease of land, a liquidator needs leave from the Court in order to disclaim contracts.  This case concerned the ambit and effect of these statutory provisions.
 
First instance decision - Re Willmott Forests Ltd [2012] VSC 29  
 
The question which Justice Davies, then of the Victorian Supreme Court, had to address was whether the disclaimer of a lease by the liquidator of the landlord had the effect of extinguishing the tenant’s leasehold interest.
 
Davies J held  that the liquidators could disclaim a lease agreement (being a contract) under s568(1) of the Corporations Act but, since a lease creates both contractual rights and a proprietary interest, the tenant’s leasehold interest remained intact despite disclaimer of the lease contract.  The primary basis for this finding was her Honour’s view that a leasehold interest was not a liability or encumbrance on the property of the landlord and it was not necessary to extinguish such an interest in order to release the landlord or its property from a liability.   Even if the contract establishing the lease was disclaimed, the Growers still had the right to possession and quiet enjoyment of the land.   This meant that the liquidators could not deliver unencumbered title under the sale contracts.
 
The Court of Appeal’s decision - Re Willmott Forests Limited (Receivers and Managers appointed) (in liquidation) [2012] VSC 202
 
WFL’s liquidators appealed to the Victorian Court of Appeal, which overturned the first instance decision. 
 
The Court of Appeal held  that the effect of disclaiming the contract for lease was to distinguish the leasehold interest itself, because:
 
  • the landlord’s obligation to provide quiet enjoyment was an ongoing liability and in order for the landlord to be relieved of that liability, the “tenure must go”; 
  • the leasehold interests here were established via contracts for lease, and there was High Court authority that the ordinary principles of contract law apply to leases, such that any leasehold interest could not survive the termination of the very contract which created it and regulated the tenure;  and
  • section 568 of the Corporations Act enabled a liquidator to release the company from obligations which would prevent a prompt and efficient winding up of the affairs of the company, such that the interests of creditors took precedence.
The High Court’s decision
 
The judges all took the view that there were two main questions before the Court: does s 568(1) of the Corporations Act give the liquidator power to disclaim a lease which the company granted to a tenant; and, if so, what is the effect of that disclaimer in relation to the tenant’s rights under the lease? 
 
The Growers had argued that it was only the liquidator of a tenant, not a landlord, who could disclaim a lease, on the basis that the only property which the landlord (via the liquidator) could disclaim was its reversionary interest in the land.  The majority interpreted this as an argument that the leases are not property of the company for the purposes of s568(1).   The Growers had also argued that, if WFL’s liquidator could disclaim a lease, it did not have the effect of extinguishing the Growers’ leasehold interests.
 
In a majority judgment, Justices French, Hayne and Kiefel held that the liquidator of the landlord company has the power to disclaim a lease and that the effect of that disclaimer was to terminate both the company’s liability to provide the tenant with quiet enjoyment of the leased property (and not derogate from the grant of a right of exclusive possession) and the tenant’s right to quiet enjoyment (and non-derogation from the grant).  Justice Gageler, writing a separate but concurring judgment, came to the same result.
 
The majority held that a lease granted by the company in liquidation to a tenant is a contract within the meaning of s568(1)(f) of the Corporations Act.   Since ‘property’ in s568 has a wide meaning, referring to “the company’s possession of any of a wide variety of legal rights against others in respect of some tangible or intangible object of property”, the doctrine of estates “cannot inform, let alone limit,” the scope of the word ‘property’.   Therefore, the reference in the section to ‘a contract’ identifies the rights and duties which arise under the contract.   Earlier High Court authority  had “firmly established that a lease is a species of contract”.    The landlord’s rights and duties are therefore a form of property, consisting of the contract of lease.   After reviewing the cases and the extrinsic material for the introduction of the current form of the relevant legislative provisions, the majority concluded that there was nothing to suggest that the reference in s 568(1A) to ‘a lease of land’ should be confined to ‘leases to the relevant company’.  
 
Since the liquidators had the power to disclaim a lease pursuant to which the company was the landlord, the majority then considered the effect of that disclaimer on the tenant’s interest.  It was held that the landlord’s “rights, interests and liabilities in respect of the leases cannot be brought to an end without bringing to an end the correlative liabilities, interests and rights of the tenants”, so that to release the company from liability, it is necessary to terminate the tenant’s rights, which operates to terminate the tenant’s estates or interests in the land.
 
In a dissenting judgment, Justice Keane held that the liquidator of a landlord company could not disclaim a lease, taking the view that a lease per se was not property of the landlord company but was only property of the tenant.   Accordingly, he held that if the liquidator wanted to disclaim the contract for lease, then that could only be done with the leave of the Court.   Even if such leave had been obtained (it had neither been sought nor obtained in this case), then the effect of the disclaimer would be to release WFL from further observance of its obligations under the leases, but it would not deprive the Growers of their right to possession for the balance of the term, to the extent that a court of equity would restrain an attempt to deprive the Growers of their right to possession.   Since all rent had been paid in this instance, it could be concluded that a court of equity would be likely to restrain such an attempt.
 
Implications
 
A tenant whose lease has been disclaimed by the landlord’s liquidator can prove in the winding up as a creditor for losses arising from the disclaimer.
 
The majority judges in the High Court expressly noted that a number of related aspects were not dealt with in this case: they stated that they did not have to consider whether the liquidators required leave of the Court in this instance or what considerations would inform the decision to grant or refuse leave; and the issue of whether the Court would set aside a disclaimer did not arise.  A person with interests in the disclaimed property (such as a Grower) can apply to the Court to set aside the disclaimer, which the Court may do only if satisfied that the disclaimer would cause prejudice to that interested person that is grossly out of proportion to the prejudice that setting the disclaimer aside would cause to the company’s creditors.
 
Accordingly, if WFL’s liquidators do proceed to disclaim the Growers’ leases, the issue of whether leave is needed (and what conditions may attach) or whether there is grossly disproportionate prejudice may subsequently receive judicial consideration.
 
This decision will be closely analysed by insolvency lawyers and liquidators, as well as property lawyers.  It clearly confirms a liquidator’s right to disclaim leases granted by the company, with the effect of extinguishing the tenant’s interest in the land.  This will be important for liquidators when determining how to realise the company’s assets and wind up the company.  The decision may cause tenants some concern, particularly long-term tenants who have injected a great deal of capital into their tenancies, as the security of their tenure may be linked to the solvency of their landlord.  This also has implications for tenants when raising finance for their business activities.