In brief - High Court confirms that liquidators of landlord companies can disclaim leases, terminating lessees' rights

On 4 December 2013, the High Court of Australia delivered its judgment in Willmott Growers Group Inc v Willmott Forests Limited (Receivers and Managers Appointed) (In Liquidation) [2013] HCA 51. The majority found that under the Corporations Act 2001 (Cth), a liquidator of a landlord company has the power to disclaim a lease granted to a lessee, and the disclaimer terminates the lessee's rights arising under the lease.

It remains unclear what this means in terms of compensation for a lessee whose lease has been disclaimed by the liquidator of a landlord, and how in practice a liquidator would go about the process of disclaiming such a lease.

Managed investment schemes for forestry operations

Willmott Forests Limited ("Willmott Forests") was the responsible entity and/or manager of a number of registered and unregistered managed investment schemes (MIS). The MIS were forestry operations conducted on land either owned by Willmott Forests or leased by Willmott Forests from third parties.

The MIS members ("the Growers") had rights to grow and harvest trees on that land pursuant to project documents, including lease and licence agreements with Willmott Forests for the use and occupation of the land.

Liquidators seek to terminate or extinguish rights of Growers

After liquidators were appointed to Willmott Forests, they entered into contracts for the sale of part of the land, unencumbered by the rights of the Growers conferred by the project documents (including the leases and licences). A transfer of clear title to the land could not be effected unless the Growers' rights were terminated or extinguished.

On 29 June 2011, the liquidators sought and obtained orders from the Federal Court including an order that they were justified in disclaiming the project documents of the contractual and partnership MIS as onerous (including the leases and licences) pursuant to section 568(1) of the Corporations Act, on the condition that the court's consent was obtained before doing so.

First instance decision: disclaimer of lease does not end lessee's proprietary interest

It is well recognised that a liquidator of a company may terminate a lease under which the company was a lessee. In this case, the company, Willmott Forests, was the lessor.

The liquidators then applied to the Supreme Court of Victoria. At first instance, Davies J found that:

  • a lease creates both contractual and proprietary rights;
  • under section 568D(1) of the Corporations Act, the effect of a disclaimer is to terminate "the company's rights, interests, liabilities and property in or in respect of the disclaimer property, but does 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";
  • although disclaimer of a lease agreement by the liquidator of a lessee would terminate all of the lessee's rights arising from that lease agreement, including by extinguishing the lessee's leasehold interest, this is not the case with the disclaimer of a lease contract by the liquidator of a lessor;
  • a leasehold interest is the property of the lessee, and disclaimer of the lease by the liquidator of the lessor only terminates the lessor's rights, interests and liabilities under that lease. Such a disclaimer would not bring the lease to an end for all purposes, and "would not bring the tenant's proprietary interest in the land to an end";
  • a leasehold interest cannot be described as a liability or encumbrance upon the property of the lessor and it is not necessary to extinguish such an interest to release the lessor or its property from a liability.

Court of Appeal decision: disclaimer of lease extinguishes leasehold interest

Davies J's decision was subsequently overturned by the Victorian Court of Appeal. The liquidators argued that disclaimer of the lease agreements would have the effect of extinguishing the leasehold interest of the Growers under section 568D(1) as this was "necessary to release the company and its property from liability". The court found that if the contract was disclaimed, the leasehold interest would also be extinguished, concluding that

...any leasehold interest cannot survive the termination of the very contract that created it and regulated the tenure of the Grower. It is this tenure which creates, and is the basis of, the obligation or liability on the part of [Willmott Forests] to provide quiet enjoyment. Section 568D(1) allows the liquidator to terminate this obligation or liability despite its intrusion into the property rights of an innocent third party. The evident policy is to permit the loss of these rights in order to enable the company in liquidation to be free of obligations so that it can be wound up without delay for the benefit of its creditors. To compensate, the rights of the affected parties are transmuted into various statutory rights and claims.

Does a liquidator have the power to disclaim a lease granted by the company to a tenant?

Special leave was then granted to the Growers to appeal the Court of Appeal's decision. In a 4:1 judgment, the majority (French CJ, Hayne, Kiefel and Gageler JJ) dismissed the appeal. Keane J provided a dissenting judgment.

French CJ, Hayne and Kiefel JJ identified the relevant questions as being: (1) does section 568(1) give a liquidator the power to disclaim a lease which the company granted to a tenant; and (2), if a liquidator has power to disclaim such a lease, what does section 568D(1) provide to be the effect of that disclaimer?

High Court majority decision: leases may be disclaimed, liabilities of lessor terminated

In relation to the first question, their Honours found that the leases to Growers were property of the company which may be disclaimed, with each lease being a "contract" within section 568(1)(f).

In relation to the second question, their Honours found that the liabilities of Willmott Forests that would be terminated by the disclaimer of the leases included its obligations to provide quiet enjoyment and not derogate from the grant of exclusive possession of the land. It necessarily followed that the tenants' rights to quiet enjoyment and non-derogation were terminated by the disclaimer of the leases with "consequent termination of the company's correlative liabilities or duties". Their Honours found that it therefore followed that the tenants' estates or interests were also brought to an end.

Gageler J, delivering his own judgment, found that the liquidators of Willmott Forests had the power to disclaim the leases on the basis that they were contracts between Willmott Forests and the Growers, pursuant to which Willmott Forests had ongoing obligations to give the Growers exclusive possession of the land owned or leased by Willmott Forests.

High Court minority judgment: disclaimer not effective to deprive tenant of right to possession

In his dissenting judgment, Keane J concluded that:

  • without the leave of the court pursuant to section 568(1A), the liquidators' disclaimers were not effective at all; and
  • if the liquidators were to disclaim Willmott Forests' contracts to lease the parcels of land in question with the leave of the court, that disclaimer would free Willmott Forests from further observances of its obligations under the leases, but it would not be effective to deprive the Growers of their right to possession for the balance of the term.

His Honour noted that in his view the Growers' interests under their leases would be sufficient to support the grant of an injunction to prevent the liquidators taking possession of the land leased to them.

Potential issues: tenant compensation, leave requirements, assessment of prejudice

It is interesting to note that French CJ, Hayne and Kiefel JJ foreshadowed some potential issues that may arise as a result of their decision and which were not explored in argument.

Section 568(9) does give the court power to award the affected party damages, and section 568(11) acknowledges that such amount may be proved as a debt in the winding up of the company. Their Honours observed that a tenant whose lease has been disclaimed by the liquidator of a landlord may consider that simply being left to proof as an unsecured creditor in the winding up gives little effective compensation for what has been taken away.

Their Honours further noted that there had been no occasion to consider whether:

  • the liquidators required the leave of the court under section 568(1A) before disclaiming the investors' leases or could disclaim as of a right without leave of the court under section 568(1); and,
  • if they did require leave, what considerations would inform the court's decision to grant or refuse leave.

Their Honours further noted that the Act expressly provides that the court on application may set aside a disclaimer only if satisfied that the disclaimer would cause prejudice to persons with interests in the property that is "grossly out of proportion to the prejudice that setting aside the disclaimer would cause to the company's creditors". Whether or how that provision would apply in this case was not canvassed.

It will be interesting to observe how these issues are dealt with in future decisions.