Last week the Victorian Court of Appeal (Warren CJ, Redlich JA and Sifris AJA) handed down judgment in the Willmott Forests Ltd appeal – Willmott Forests Ltd (Receivers and Managers appointed)(in liquidation) v Willmott Growers Group Inc and Willmott Action Group Inc [2012] VSCA 202. The judgment in full may be read here.

The question on appeal was whether or not a leasehold interest in land is extinguished by the disclaimer of the lease agreement by the liquidator of the lessor, pursuant to s 568(1) of the Corporations Act 2001 (Cth) (the Act). In short, the Court of Appeal held that it was. In February, Davies J of the Victorian Supreme Court had held that it was not. My earlier analysis of her Honour’s judgment may be read here.

[For completeness: Davies J subsequently handed down her judgment on the balance of the questions upon which judicial advice had been sought by the liquidators of Willmott Forests Ltd (WFL) pursuant to s 511 of the Act in April. That judgment was not part of this appeal, which concerned solely the preliminary question her Honour had decided  in February. However, should you wish to read my analysis of her Honour’s April judgment, it may be accessed here.  It includes an overview of the Willmott Forests managed investments schemes and how they were structured. Under sub-heading 3(a) “Allocation of Sale Proceeds”, there is also a useful sketch of the practical circumstances of the scheme plantations and how they were operated.]

Background

Broadly, WFL had leased certain properties to Growers (the investors in the schemes) on 25 year terms, upon which land the various Willmott Forests plantations were situated. WFL was the responsible entity and/or manager of the various forestry managed investment schemes. WFL’s liquidators wished to sell WFL’s interest in the properties, unencumbered by the leases. The liquidators proposed to disclaim the lease agreements in order to achieve and complete the sales, and sought court approval of such disclaimers and judicial advice as to certain questions that arose therefrom.

At First Instance

At first instance, before Davies J the Growers/lessees had argued that disclaimer of the lease contracts does not extinguish their proprietary interest in the land. Davies J agreed. Her Honour also held that the leasehold interests could not be characterised as liabilities or encumbrances upon the property of the lessor, and it was consequently not necessary to extinguish such interests.

For a more detailed understanding of how the lessees’ argument was mounted – and accepted – I refer you to my earlier post here. For present purposes, the judgment on appeal of Warren CJ and Sifris AJA  at [20] includes a very neat summary of the reasoning of Davies J’s first instance judgment as follows –

(a) A lease creates both contractual and proprietary rights;

(b) Under s 568D(1) of the Act, the effect of a disclaimer is to terminate ‘the company’s rights, interests, liabilities and property in or in respect of the disclaimer property, but 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‘ [emphasis added],

(c) Although disclaimer of a lease agreement by the liquidator of a lessee would terminate all of the lessee‘s rights arising from that lease agreement, including by extinguishing the lessee‘s leasehold interest, this is not the case with the disclaimer of a lease contract by the liquidator of a lessor, [I note that the leading authority on point of Hindcastle Ltd v Barbara Attenborough Associates Ltd [1997] AC 70 was a case of disclaimer by a tenant. Her Honour held that it was expressly confined to the case of disclaimer by a tenant, and declined to apply it to the reverse position here, of disclaimer by a landlord. I note that their Honours on appeal took the opposite view, see below]

(d) A leasehold interest is the property of the lessee and disclaimer of the lease by the liquidator of the lessor only terminates the lessor‘s rights, interest and liabilities under that lease (and other persons’ rights and liabilities only to the extent necessary). Such a disclaimer would not bring the lease to an end for all purposes. Specifically, such a disclaimer ‘would not bring the tenant’s proprietary interest in the land to an end’,

(e) A leasehold interest cannot be described as a liability or encumbrance upon the property of the lessor and it is not necessary to extinguish such an interest to release the lessor or its property from a liability.

The Appeal

The liquidators appealed her Honour’s decision, arguing before the Court of Appeal that disclaimer of the lease agreements would have the effect of extinguishing the leasehold interest of the Growers, under s 568D, as this was “necessary to release the company and its property from liability“.

Counsel for the Growers argued that the rights of the Growers as lessees would have accrued or become vested at the time of any disclaimer and would therefore be preserved. However their Honours disagreed, saying at [32] that the continuing and prospective obligation on a lessor to provide possession and quiet enjoyment to a lessee is not a fully accrued obligation or liability that cannot be terminated. Counsel for the liquidators of WFL argued that the word liability in s 568D(1) was wide enough to embrace the continuing obligation on the part of WFL to provide quiet enjoyment; their Honours agreed (applying Hindcastle). At [37], their Honours said this –

“If WFL is to be relieved of its obligation to provide quiet enjoyment, clearly and in context a liability, the interest of the lessee so far as tenure is concerned is directly related to and underpins such liability. The tenure must go. It is necessary to affect the Growers’ rights (tenure) in order to release WFL from its liability (possession and quiet enjoyment). The cases where rights have been preserved usually involve claims against third parties unrelated to any liability of the company in liquidation.”

Their Honours then considered at [38] whether, notwithstanding the termination of the interests of the lessee under the disclaimed contract – as necessary to relieve WFL from liability – the asserted leasehold interest remains. The trial judge had held that it did. Their Honours held that it did not. Their Honours observed succinctly that, in their opinion, if the contract is disclaimed, the leasehold interest is also extinguished [at 39]. Their Honours Warren CJ and Sifris AJA then gave detailed consideration to authorities as to lease contracts and the rights that arise under them, including the doctrines of frustration and repudiation.

At [49-50] their Honours described the principle from  Hindcastle (disclaimer of lease by tenant extinguishing the tenant’s interest in the property) and noted that they did not understand Lord Nicholls to suggest that the same consequences – determination of the leasehold interest – would not apply in the case of the liquidation of the landlord. They concluded discussion of that authority with a rhetorical question: “Why should the consequences differ if the underlying event that informs the consequences, namely termination of the contract, is the same?” With that, their Honours clearly took the view that the principle in Hindcastle could and should be extended to the case of disclaimer of leases by the landlord.

Their Honours concluded [at 58] as follows –

“For the reasons given, any leasehold interest cannot survive the termination of the very contract that created it and regulated the tenure of the Grower. It is this tenure which creates, and is the basis of, the obligation or liability on the part of WFL to provide quiet enjoyment. Section 568D(1) allows the liquidator to terminate this obligation or liability despite its intrusion into the property rights of an innocent third party. The evident policy is to permit the loss of these rights in order to enable the company in liquidation to be free of obligations so that it can be wound up without delay for the benefit of its creditors. To compensate, the rights of the affected parties are transmuted into various statutory rights and claims.” His Honour Redlich JA wrote a separate judgment, but reached the same conclusion.

A notable and important point:  Warren CJ and Sifris AJA appeared to be supported in their conclusions by the fact that the leases where not simple, Blackacre leases, but were one part of a suite of inter-related documents regulating the rights and liabilities of the various parties in these tax-driven managed investment schemes. The Growers/investors’ resources were pooled and they permitted a manager to attend to all the necessary work. In this context as with shopping centre leases, so their Honours observed at [51], it is difficult to regard the Growers/investors as holding a leasehold interest or estate. “The better view is that there is no demise of the kind that would survive any termination of the very contract that created the tenure.” And at [52]: “The notion that a commercial lease is a demise that confers an interest in land and survives the termination of the contract creating the demise is to ignore recent, significant developments in the law that suggests otherwise.”

This then would suggest that the principle for which this decision will stand authority may not apply to more simple, straightforward leases of land, as opposed to shopping centre leases (as expressly cited by their Honours) or complex commercial lease agreements, particularly those forming part of broader commercial schemes or arrangements.

Some have said that this judgment represents new law. Others may take the view that it clarifies the correct position of the law on this issue. I will leave it for you to decide. Either way, it is an important decision for insolvency and property law practitioners to be aware of and appreciate. It will be interesting to see if the Growers seek special leave to appeal the decision.