Security of Tenure for Tenants

The High Court has recently dismissed an appeal bought by Willmott Growers Group (Growers) in relation to the decision of the Court of Appeal in Victoria.1 The High Court, by majority, confirmed that the liquidator of a landlord company has power under Division 7A of Part 5.6 of the Corporations Act 2001 (Cth) (Act) to disclaim a lease and effectively, terminate a landlord’s obligations and the tenant’s estate and interest in land.2

Background

William Forests Limited (Willmott) was the manager of a number of commercial forestry schemes. As part of that scheme, Willmott leased to participants portions of land which it owned or leased. In March 2011, Willmott’s creditors resolved to wind up the company and appointed liquidators.

The liquidators sought to sell the assets of Willmott including its land, subject to the scheme and existing tenancies. However, after there was no interest in purchasing the assets or land subject to existing tenancies, the liquidators negotiated sale contracts which were not subject to any encumbrances.

Specifically, the liquidators concluded that the schemes could not continue to operate and that it was very unlikely that a party would be willing to take over Willmott as responsible entity or manager where it would be required to assume the liabilities of Willmott.  Accordingly, Each sale contract provided that title to the land or assets the subject of the contract would pass to the purchaser free of any encumbrances in connection with the scheme. 

The liquidators approached the Supreme Court of Victoria pursuant to section 511 of the Act for directions and orders in respect of the sales that had been negotiated. The liquidators sought to disclaim the lease pursuant to section 568(1) of the Act.

Legislation

Section 568 of the Act gives liquidators the power to disclaim certain property of a company, including property consisting of a “contract”.  Section 568D provides that a disclaimer is taken to terminate a company’s rights, interests, liabilities and property in or in respect of the disclaimed property.  There is a carve-out in this provision that such disclaimer “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”.

Her Honour Justice Davies rejected the liquidators’ purported disclaimer of the leases, finding that it was not “necessary” to interfere with the Growers’ property rights in order to discharge Willmott from its liability to lease. Justice Davies accepted the Growers’ contention that the disclaimer could only relate to Willmott’s reversionary interest in the lease, and could not affect the tenants’ rights.

The Court of Appeal reversed this decision, concluding the extinguishment of the tenants’ rights is a direct consequence of the need to release Willmott from liability.

High Court Decision

By special leave, the Growers appealed to the High Court, and raised two main arguments:

  1. That the disclaimer of the leases should only affect the reversionary interest of Willmott, not the tenants’ rights under the leases. Specifically, the Growers submitted that earlier decisions establish that a vested interest in land cannot be brought to an end by disclaimer of the contract which created that interest.
  2. The disclaimer took effect only to the “extent necessary” to release Willmott from its liabilities, and would not affect third parties’ rights under the leases, including the Growers’ leasehold interests.

The Court rejected the first argument, which was essentially a question of construction - whether a lease granted by Willmott was “a contract” pursuant to section 568(1)(f). By interpreting the lease as “a contract” capable of being disclaimed, the Court rejected the contention that the disclaimer could only affect the reversionary interest of Willmott. Effectively, the liquidators had the power to disclaim the leases and thereby terminate Willmott’s rights, interests and liabilities in respect of the leases.

In respect of the second argument, the Court concluded that termination of the Growers’ rights under the leases was a direct consequence of the extinguishment of Willmott’s liabilities. For example, terminating a landlord’s obligation to provide its tenant with quiet enjoyment of the premises necessarily extinguishes a tenant’s correlative right to such quiet enjoyment.

Accordingly, a tenant aggrieved by the operation of the disclaimer is taken to be an unsecured creditor of the company, and may prove its loss as an unsecured debt in the winding up of the company.3  As the High Court noted, this is unlikely to provide effective compensation for what has been taken away.

Comment

The High Court decision highlights the risks for tenants and financiers taking security over tenant’s interests in leasehold property.  Tenants and financiers may not be protected in the event the landlord company goes into liquidation. 

The decision leaves unanswered whether liquidators require the leave of the court under section 568(1A) before disclaiming a lease and in what circumstances a court may set aside a disclaimer under section 568B(3).  Section 568B(3) enables a court to set aside a disclaimer 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”.

It also remains to be seen, whether registration of a lease will impact on a liquidator’s disclaimer of lease.In Victoria leases are not registered whereas registration is required for long term leases in most other Australian jurisdictions. Similarly it also remains to be seen whether a liquidator can disclaim a lease where it is not the original landlord or the tenant is not the original tenant.  In these circumstances there is no “privity of contract” between the parties but merely “privity of estate”.