Disclaimer of lease by a landlord's liquidator

Most disclaimers of lease occur when a liquidator is appointed to an insolvent tenant company. After conducting enquiries and ascertaining that it is unprofitable to keep the insolvent company operating, the liquidator is then able to 'disclaim' the lease by giving notice to the landlord. The effect of this is that the lease comes to an end immediately and the liquidator has no further obligations to the landlord. This procedure is intended to allow a prompt and efficient winding up of the affairs of the insolvent company.

However, what happens when a liquidator is appointed to an insolvent landlord company? Is the liquidator able to disclaim the lease, against the interests of the innocent tenant?

These issues were considered in a recent Supreme Court of Victoria decision, Re Willmott Forests Limited (in liquidation) [2012] VSCA 202.

Background

The circumstances of the case involved a managed investment scheme in relation to investments in forestry plantations. The relevant participants in the scheme were:

• Willmot Forests Limited, being the responsible entity of the scheme, and the landlord under the scheme leases (WFL); and
• Willmot Growers Group Inc, being the members of the scheme, and the tenants under the scheme leases (the Growers).

Under the scheme arrangements, the Growers had rights to grow and harvest trees on land leased from WFL. The scheme leases were for 25 years and, in accordance with the tax driven nature of the scheme, only limited rents were payable to WFL by the Growers.

WFL went into liquidation. Usually a liquidator of a landlord would view 'income producing leases' as an asset, and would seek to sell the leased land, together with the right to collect the rent payable under the leases. However, in this case, the liquidator considered that the scheme leases were in fact a liability, and that the land was more valuable without being subject to the scheme leases.

The liquidator then entered into sale contracts with an independent purchaser, but the contracts were conditional upon the liquidator being able to disclaim the scheme leases and sell the land with vacant possession.

Section 568(1) of the Corporations Act 2001 contemplates that a liquidator may disclaim a wide range of property and contracts, and the liquidator applied to the Court for the disclaimer of the scheme leases.

The Growers objected to the liquidator's application to the Court on the basis that the Growers would be unduly disadvantaged if the disclaimer of the scheme leases was granted because:

• the Growers would lose their past investment in the scheme and their ability to derive future profits from the scheme; and
• the Growers would be reduced to the position of being creditors of WFL and then have to prove their loss in the winding up of WFL.

The Court's decision

The Court discussed a number of interesting issues regarding the contractual and property rights in relation to leases, and how these rights are affected by a liquidator's power to disclaim a lease.

The Court noted that:

• the historical position is that a lease is somehow different to a contract because a lease contains both contractual rights between the landlord and the tenant, and also creates a leasehold interest in the land in favour of the tenant. It is therefore often argued that a leasehold interest in land is not extinguished by the disclaimer of the lease by the liquidator;
• however, that historical position is no longer relevant because a modern lease is essentially a complex contract between the landlord and the tenant, which is more appropriately governed by all of the usual contractual laws and rules; and
• on this basis, the scheme leases granted by WFL to the Growers were contracts that could be disclaimed by the liquidator. In addition, the leasehold interests in the land granted to the Growers by the scheme leases were extinguished at the same time that the scheme leases were disclaimed by the liquidator.

The significance of the decision

The Court's decision will provide some guidance to liquidators of insolvent landlord companies who wish to disclaim leases to tenants that:

• contain financial obligations which bind the insolvent landlord, but which cannot be recouped or offset against the rental income stream;
• render the insolvent landlord's freehold interest unsaleable or reduce the prospects of a sale; or
• are otherwise detrimental to the value of the land owned by the insolvent landlord (for example, tenant-friendly leases where the rent is significantly below the market rate).

However, it should be noted that:

• an affected tenant may seek to set aside a disclaimer on the basis that the tenant will suffer prejudice that is out of proportion to the prejudice that would be suffered by the creditors of the insolvent company if the tenant's lease was allowed to continue; and
• it is not yet clear, but it is likely, that Courts will apply the decision in this case to particular types of leases, and not to usual commercial leases where tenants are up-to-date with the payment of a normal market rent.

The above summary reflects the current position, but the Growers are seeking to appeal the decision. Watch this space.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.