In the recent Court of Appeal decision of Re Willmott Forests Ltd [2012] VSC 29, the Court held that a lessee’s leasehold interest can be extinguished by a liquidator appointed to a lessor company using the disclaimer power in s 568 of the Corporations Act 2001 (Act). 

Facts

Willmott Forests Ltd (WFL) owned and leased from third parties freehold properties that it then leased to tenants (growers) under lease agreements. When WFL went into liquidation the liquidators sought to sell WFL’s interest in the properties. As part of the sales, WFL’s liquidators proposed to disclaim the lease agreements with growers in order for them to sell the land unencumbered. The liquidators applied to the court for approval of the disclaimers.

At first instance, the trial judge found that section 568 of the Act could not be used to extinguish any of the growers’ interest in the land.  The liquidators appealed.

Decision: Consequences of Disclaiming Lease Agreements

The Court considered section 568D of the Act which sets out the effect of a disclaimer as follows:

  1. to terminate the company’s (lessor’s) rights, interests, liabilities and property in the disclaimed property; and
  2. another person’s property” is only affected if it is necessary to release the company (lessor) and its property from liability.

The Court found that WFL had an ongoing liability under the leases to “provide the lessee with possession and quiet enjoyment”. The Court accepted that by disclaiming the contract (lease), WFL would no longer have any contractual rights or liabilities under the contract and would no longer be required to perform its part of the contractual bargain. The question therefore became whether it was necessary to extinguish the growers’ interests in the property in order to release WFL from its liability under the leases.

The Court held that disclaiming the leases would have the effect of terminating the growers’ interests in the leases. The Court gave the following reasons:

  1. the continuing and prospective obligation to provide possession and quiet enjoyment is not a fully accrued obligation or liability that cannot be terminated;
  2. section 568 of the Act is specifically designed to enable a liquidator to cease performing obligations and to achieve a release of the company in liquidation from its obligations. The Court explained, “if WFL is to be relieved of its obligation to provide quiet enjoyment, clearly and in a context of liability, the interest of the lessee so far as tenure is concerned is directly related to and underpins such liability. The tenure must go”; and  
  3. the leasehold interest is governed by the contract of the lease and the lease itself is therefore governed by the law of contract. There is no reason why the consequences of a disclaimer of a lease should be treated any differently to a repudiation accepted by a non-defaulting party. The Court explained, “in both cases, the lease agreement is at an end and what follows is a matter of law, namely termination of the leasehold interest that does not depend in any way on the reason for such termination”.    

Ramifications: the Lessee’s Options upon Disclaimer of a Lease Agreement

The decision is likely to have far reaching consequences for lessees where a lessor goes into liquidation.  There is a real risk that any lease of property owned by the lessor company will be disclaimed, and a lessee’s interests in property extinguished.  In those circumstances the lessee has the following options: 

  1. the Act provides that the lessee can prove as an unsecured creditor in the winding up of the lessor company for any losses suffered as a result of the disclaimer;
  2. the Act sets out a process by which a lessee can apply to the Court to have the disclaimer set aside (section 568B(1) of the Act).  The Court will only set aside a disclaimer if the lessee has established that the disclaimer would cause it prejudice that is “grossly out of proportion to the prejudice that setting aside the disclaimer would cause to the company’s creditors”; and
  3. try to negotiate a new lease with the liquidator.