Liquidator disclaims - High Court proclaims

The High Court of Australia recently considered two issues relating to a liquidator's power to disclaim a lease granted by the company in liquidation. The first issue was whether a lease is a "contract" for the purposes of section 568 of the Corporations Act 2001 (Cth) (Act). The second issue was whether the disclaimer of a lease (if available to the liquidator) terminates the tenant's leasehold estate.

The majority of the High Court determined that a lease is a contract for the purposes of section 568 of the Act, and that the disclaimer of a lease terminates the tenant's right, title and interest in the leased property. That is, the liquidator's disclaimer extinguished the tenant's proprietary interest in the leased property.

The result of the High Court's findings has potentially significant implications for landlords and tenants, including, most significantly, the uncertain tenure of a tenant's right of occupation of leased property and the risk carried by a tenant in relation to the landlord's solvency.

However, it should be noted that the Act provides the Court with power to set aside a disclaimer, including after it has taken effect, where the prejudice arising from the disclaimer is grossly out of proportion to the prejudice that setting aside the disclaimer would cause to:

a) the company's creditors; and

b) in the case of an application to set aside the disclaimer after it has taken effect, persons who have changed their position in reliance on the disclaimer taking effect.

The Court's power to set aside a disclaimer was not considered by the Court, but provides a possible avenue for a tenant to avoid the loss of tenure of leased premises on disclaimer of the lease. Specifically, if the rent is "market" the lease should not detract from the value of the property and there are prospects of obtaining an order setting aside a disclaimer.

The best way to minimise risk arising from the High Court decision may be to:

1. choose, where possible, to occupy premises which are owned by landlords who are financially sound; and
2. avoid paying lease premiums upfront in return for sub-market rentals down the track, so that the lease does not develop negative value to a landlord as the lease term progresses.

Background

Section 568 of the Act gives the liquidator of a company power to disclaim certain property of the company, including property that consists of a contract.

Section 568D(1) of the Act provides that disclaimer terminates the company's rights, interests, liabilities and property in or in respect of the disclaimed property from the effective date of the disclaimer. However, the Act does not address the effect of the disclaimer on any other party with rights in the disclaimed property, other than to confirm that the other party has a right to lodge a proof of debt in the liquidation pursuant to section 568D(2) of the Act.

The issues in this appeal arose in the liquidation of Willmott Forests Limited (Receivers and Managers Appointed) (In Liquidation) (Willmott Forests).

On an application for directions by the liquidators of Willmott Forests, the judge at first instance, Davies J determined that the liquidators are not able to disclaim tenants' (growers) leases with the effect of extinguishing the tenants' leasehold estate or interest in the subject land.

On appeal to the Full Court of the Supreme Court of Victoria, Her Honour's judgment was overturned, with the Full Courtfinding that the disclaimer of a lease in turn terminated the tenant's leasehold estate or interest in the leased property.

The High Court appeal

The appellant in the High Court, who acted on behalf of a group of Growers in the Willmott Forests Managed Investment Schemes (Growers) submitted that termination of the landlord's rights, interests, liabilities and property in or in respect of the disclaimed lease did not bring the tenant's rights in the leased property to an end. The Growers argued that the tenant's leasehold estate in the leased property was a separate and distinct proprietary interest from the landlord's rights, interests and liabilities.

The majority of the Court disagreed with the Growers' submissions and held that, "it necessarily follows that, from the effective date of the disclaimer, the [landlord]company's liability to provide the tenant with quiet enjoyment of the leased property (and not derogate from the grant of a right to exclusive possession) and the tenant's rights to quiet enjoyment of the property (and non-derogation from the grant of exclusive possession) are terminated."¹

The majority of the Court came to this conclusion because, "in every case the tenant is the party that has the liability, interest or right which is correlative to the relevant right, interest or liability of the company. And contrary to the submissions of [the Growers], the company'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. That is, … in order to release the company … from liability, it is necessary to terminate the tenants' rights under the leases."²

Issues not considered by the High Court

The matters considered by the High Court were confined to the two issues set out above. The High Court was not required to (and did not) determine:

1. whether the liquidators required leave of the Court before disclaiming the tenants' leases and, if so, what factors should be taken into account in considering whether leave should be granted;
2. the criteria to be applied to an application under sections 568B and 568E of the Act to set aside a disclaimer. These sections allow the Court to set aside a disclaimer if the prejudice to the lessee is grossly out of proportion to the prejudice that setting aside the disclaimer would cause to the company's creditors and (in the case of an application to set aside the disclaimer after it has taken effect) persons who have changed their position in reliance on the disclaimer taking effect. There is little guidance in the Act on how such an application should be assessed; and
3. how a liquidator's power of disclaimer is to be reconciled with relief against forfeiture provisions in State and Territory real property legislation.

Potential impacts of this decision on tenants and financiers

The High Court's decision means that tenants face the risk of losing their interest in leased premises on the insolvency of their landlord. This will have flow on consequences for matters such as:

1. a tenant's due diligence on a prospective landlord's solvency, particularly where the nature or location of the leased premises is critical to the tenant;
2. tenants may also be more reluctant to pay lease premiums upfront (as was the case with the tenants in the Willmott Forests case) in the knowledge that they may lose their leasehold interest on the insolvency of the landlord and be left with only a right to lodge a proof of debt in the landlord's liquidation and receive any dividend pro rata with all other unsecured creditors; and
3. the value of a leasehold interest in land can "evaporate" if the lease is successfully disclaimed, which will impact on what financiers may be willing to lend to a tenant reliant on a leasehold interest.

Whilst these matters may be taken into account by a Court in assessing an application under section 568B of the Act to set aside a disclaimer, they no doubt increase the need for scrutiny by a tenant before entering into significant lease arrangements.

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