A liquidator's disclaimer of a lease extinguishes a tenant's leasehold interest

A recent decision of the Victorian Court of Appeal has confirmed that a liquidator of a landlord can disclaim a lease with full effect, so that the land is no longer encumbered by a tenant's interest.

In Re Willmott Forests Limited (Receivers and Managers appointed) (in liquidation) [2012] VSCA 202, the Court of Appeal overturned the Court's decision at first instance which held that a lease could be disclaimed while the tenant's leasehold interest remained intact.

The decision will give liquidators the certainty of knowing that disclaimer of a lease means that a tenant no longer has any interest in the land.

Background

The landlord, Willmott Forests Ltd (WFL), was the responsible entity of a collection of agricultural managed investment schemes (MIS).

The members of the MIS (Growers) leased land owned by WFL to grow and harvest trees pursuant to lease and licence agreements.

WFL went into liquidation and the liquidators entered into sale contracts for the sale of WFL's land.

However, clear title could not be transferred under the contract unless the Growers' rights and entitlements under the leases and licences were terminated or extinguished.

The liquidators applied to the Court for directions as to whether or not they could disclaim the leases under section 568(1) of the Corporations Act 2001 (Cth) to enable them to transfer clear title to the land.

The first decision

At trial, the Court held that a liquidator could disclaim a lease under section 568 of the Act but that this would not terminate a tenant's proprietary rights (its leasehold interest) in the land, which continue despite disclaimer.

The Court emphasised that a lease is not only a contract between the parties, but is also a grant by the landlord of an estate in land to the tenant.

The Court considered section 568D 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."

The Court found that a leasehold interest was not a liability or encumbrance upon the property of the lessor and, on that basis, it was not necessary to extinguish such an interest to release the lessor or its property from a liability.

The liquidators appealed the decision.

Why the Court of Appeal found the liquidator could disclaim the lease and extinguish the tenant's leasehold rights

The Court of Appeal overturned the trial judge's decision and unanimously held that the liquidators were able to disclaim the leases with the effect that, not only was the contract for lease disclaimed, the tenant's leasehold interest itself was extinguished.

In reaching its decision the Court made the following key findings:

• A landlord's obligation to provide a lessee with possession and quiet enjoyment (tenure) is an ongoing liability which continues for the duration of the lease. Therefore, for the landlord to be relieved of that liability the proprietary interest of the lessee must go.
• A leasehold interest is regulated by a lease contract and, like any other contract, is extinguished upon termination of the contract. A leasehold interest does not survive the termination of the contract that created it and regulated the tenant's tenure.
• The purpose of section 568 of the Act is to allow a liquidator to release the company in liquidation from obligations which would otherwise prevent a prompt and efficient winding up of the company's affairs.

Practical effects

The Willmott decision is important for liquidators, tenants (and even financiers of businesses operating from leased premises).

Liquidators will be able to disclaim a lease with the comfort of knowing that this will terminate all of the tenant's leasehold interests – this will be of particular importance to a liquidator faced with a lease which: 

• contains financial obligations binding the landlord which cannot be recouped or offset against the rental income stream; 
• renders the freehold interest unsaleable or reduces prospects of sale;
• is otherwise detrimental to the value of the land owned by the company (for example, tenant-friendly leases which may be significantly under market).

Tenants looking to secure long-term leases should consider the possibility that their leasehold interest could be extinguished by a liquidator's disclaimer.

Financiers of businesses operating from leased premises may consider adjusting their lending criteria to reflect the risk of disclaimer.

However, it should be noted that:

• it remains open to an affected tenant to seek to set aside a disclaimer (which it may seek to do if it can establish that it will suffer prejudice that is grossly out of proportion to the prejudice that setting aside the disclaimer would cause to the company's creditors);
• it is not yet clear as to whether the Court will readily apply Willmott in relation to all leases or whether it will distinguish between different types of lease – for example, a 99 year pastoral lease, which more closely resembles a freehold interest in land (and, in such a situation, whether the lessee may succeed in having the disclaimer set aside).