The recent decision of the Victorian Court of Appeal in Re Willmott Forests Limited (Receivers and Managers appointed) (in liquidation) [2012] VSCA 202 gives liquidators comfort when disclaiming leases (as the liquidator of a landlord) pursuant to s 568(1) of the Corporations Act 2001 (Cth) (‘the Act’).


At first instance, Davies J held that the disclaimer of a lease by a liquidator of the landlord did not automatically extinguish the tenant’s proprietary rights. This meant that the land was still encumbered by the tenant’s leasehold estate, so that the land could only be sold subject to that interest. The decision also left unresolved some key practical matters: if the contract for lease is disclaimed but the tenant’s proprietary interest remains, what governs that interest? For example, what rent is payable, what obligations does the tenant have, and what is the term of the lease?

The Court of Appeal’s decision is welcome in that it clarifies what would otherwise be a very difficult situation for liquidators. Leases can be disclaimed with full effect, so that the land is no longer encumbered by the tenant’s interest, which means that more options for selling or dealing with the land exist. The appeal also resolves the practical difficulties that arose from the first instance decision.

Background

Willmott Forests Limited (‘WFL’) is the responsible entity and/or manager of a collection of managed investment schemes (‘MIS’). These MIS are forestry operations conducted on land which is either owned by WFL or leased by WFL from third parties. The members of the MIS (‘the Growers’) have the right to grow and harvest trees on the land owned or leased by WFL. These rights of the Growers are governed by project documents that include lease and licence agreements between the Growers and WFL.

WFL went into liquidation and the liquidators entered into sale contracts for the sale of part of WFL’s freehold land, unencumbered by the rights of the Growers conferred by the project documents, including the leases and licences (‘the Growers’ rights’). A transfer of clear title to the freehold land from WFL to the purchaser could not be effected unless the Growers’ rights were terminated or extinguished. For some of this land, the only mechanism for extinguishing the Growers’ leasehold interests was a disclaimer of those leases.

The liquidators then approached the court for directions under section 511 approving the disclaimer of the lease agreements pursuant to section 568(1) of the Act, which would terminate the Growers’ leasehold interests.

First instance decision

The key issue for consideration was the effect of a liquidator’s disclaimer of a lease, where the company in liquidation was a landlord. Did the disclaimer have the effect of extinguishing the tenant’s leasehold interest?

At first instance, Davies J held that the liquidators could disclaim a lease agreement under section 568(1) of the Act. However, Davies J noted that a lease creates both contractual rights and a proprietary interest (leasehold interest), and in her Honour’s opinion the lease could be disclaimed by the liquidator whilst the tenant’s leasehold interest remained intact. Therefore, her Honour held that the tenant’s leasehold interest was not extinguished as a result of the disclaimer.

Her Honour based her finding on section 568D(1) of the Act, which states that any disclaimer of property should not “affect any other person’s rights or liabilities except so far as necessary in order to release the company and its property from liability”.

In her Honour’s opinion, a leasehold interest could not be described as a liability or encumbrance upon the property of the lessor; therefore, it was not necessary to extinguish such an interest to release the lessor or its property from a liability.1 Consequently, disclaiming the lease only terminates the lessor’s rights and liabilities under the lease and ‘would not bring the tenant’s proprietary interest in the land to an end’.2 Even if the lease was disclaimed, the Growers still had the right to possession and quiet enjoyment of the land due to their leasehold interest, which meant that WFL could not complete the sale contracts, as it could not give unencumbered title.

WFL’s liquidators appealed this decision to the Court of Appeal.

The Court of Appeal’s decision

The Court of Appeal overturned Davies J’s decision at first instance and found that not only was the contract for lease disclaimed, the leasehold interest itself was extinguished. The Court expressed three main reasons for this conclusion:

1. Quiet enjoyment is an ongoing liability

The Court held that the landlord’s obligation to provide the lessee with possession and quiet enjoyment (tenure) is an ongoing liability (that had not accrued or vested), which continues for the duration of the lease. The Court found that both the landlord’s liability and the lessee’s interest arise directly out of the tenure of the lease.3 Therefore, for the landlord to be relieved of its liability (to provide quiet enjoyment), “the tenure must go”.4 It was necessary to affect the lessee’s rights in order to release the landlord from its liability (to provide quiet enjoyment and possession).

2. Leasehold interests are regulated by lease contracts and therefore are extinguished when the lease is disclaimed

The Court surveyed the authorities (noting that her Honour had not been taken to these authorities during the hearing at first instance) and held that leasehold interests are governed by the law of contract, and that lease contracts regulate the substance and termination of these leasehold interests.5 The Court pointed out Mason J’s statement in Progressive Mailing House Pty Ltd v Tabali Pty Ltd6 that the ordinary principles of contract law apply to leases.7 Therefore, the consequences of disclaiming a lease are the same as the consequences of disclaiming any other type of contract.8

The Court held that any leasehold interest cannot survive the termination of the very contract that created it and that regulated the tenure of the tenant. It is this tenure which creates and is the basis of the landlord’s obligation to provide quiet enjoyment.9 The Court noted Deane J’s statement in Progressive Mailing House that the leasehold cannot be divorced from its basis in contract law, and if the contract is avoided or dissolved, the estate must suffer the same fate.10

3. The legislature intended that leases could be disclaimed

The Court found that section 568 is specifically designed to enable a liquidator to release the company in liquidation from obligations which would prevent a prompt and efficient winding up of the affairs of the company.11 Therefore, the interests of creditors take precedence over those of the affected parties.12

Importance of the decision

The decision is important for liquidators and property lawyers, as:

  • it confirms that contracts for lease are inextricably linked to their leasehold interests; therefore, if a lease is disclaimed or terminated then the corresponding leasehold interest must be extinguished. Liquidators will benefit from knowing that the disclaimer of a lease will mean that all leasehold interests of the tenant will fall away;
  • it emphasises that the speedy and efficient winding up of the company in liquidation is more important than protecting affected parties’ leasehold interests; and
  • prospective tenants contemplating long-term leases may need to consider the possibility that their leasehold interest could be extinguished through a liquidator’s disclaimer.