01 Mar 2013

Disclaimer by liquidators: divesting a company of continuing obligations

by Orla McCoy

A procedure which is followed on an almost daily basis, a lease disclaimer, may appear to be straightforward and uncomplicated, but below even the most quotidian processes lies a complex and not entirely settled body of law.

In June 2012 I wrote an article for this journal which examined the obligations and options of a voluntary administrator in relation to leased property. In particular, I remarked upon the practice of putative "disclaimer" of leases in voluntary administration (and receivership).

Shortly after the article was published, the Victorian Court of Appeal handed down its decision in Re Willmott Forests Ltd (Receivers and Managers appt'd) (in liq) (2012) 91 ACSR 182; [2012] VSCA 202. It would be somewhat of an overstatement to suggest that Willmott made the topic of leases and disclaimers exciting. However, the Court of Appeal's decision, and the first instance decision it overturned, certainly piqued the interest of insolvency practitioners and commentators in an area of law that had, up to that point, received relatively little judicial consideration, particularly given its long legislative history.[1] That was clear when the Court of Appeal decision in Willmott prompted a flood of law firm newsletters and updates to clients.

Emboldened by this surge of interest in what had appeared to be a relatively settled topic, this article will examine some other aspects of disclaimer, including the Willmott decisions and their subsequent treatment. To begin with, however, I will briefly recap the main points of my first article – for reasons which will become clear.

Administrators and leases: obligations and options

My first article was in part prompted by observing what a number of voluntary administrators and receivers do in practice. Specifically, I noticed that some administrators and receivers purport to disclaim leases which the companies to which they have been appointed are party.

Of course, the Corporations Act 2001 (Cth) does not actually empower them to do this. Rather, it sets out a separate statutory regime under which administrators and receivers may opt to give a landlord a notice of intention not to exercise the company's rights in respect of a lease.[2] The giving of the notice limits the administrator or receiver's personal liability for periodic payments but, unlike disclaimer, does not affect the liability of the company under the lease.

Both the effect of giving a notice of intention not to exercise property rights, and the procedure for doing so are very different from a liquidator's disclaimer. Of particular importance is the timeframe: administrators have five business days to give the notice, while receivers have seven days. If they do not give notice within that time, they become personally liable for the lease payments. There is no provision for extending that timeframe.[3] Notably, a notice served out of time would appear to be a nullity.

While an administrator who has failed to give a notice may seek relief from the Court for personal liability under section 443B(8) of the Act, applications under section 443B(8) are rare and require a good justification for omitting to serve the notice.

Despite this, some administrators and receivers appear, anecdotally, to be continuing the practice of issuing "disclaimer" notices, often doing so substantially outside of the statutory window for service of notices under sections 443B/419A of the Act, and without an appreciation of the legal effect (or invalidity) of the notices.

Disclaimer of onerous property by liquidators has also been subject to recent judicial scrutiny, and by way of supplement to my last article it is worthwhile briefly examining the recent authorities in this area.

Willmott

The Supreme Court of Victoria's decision in the Willmott litigation on the separate and preliminary question of whether the liquidators of a lessor could disclaim leases with the effect of extinguishing the lessees' interest, sent shockwaves through the insolvency and commercial property sectors. The decision of Davies J at first instance effectively rendered the power of disclaimer futile where the person doing the disclaiming was the liquidator of a landlord and the contract being disclaimed was a lease.

Of course, those shockwaves only lasted for a few months, until the Victorian Court of Appeal restored the status quo ante. Nevertheless, it is arguable that the first instance decision highlights an unresolved question about Division 7A of Part 5.6 of the Act, namely, are there any effective limits on what can be disclaimed (other than those enumerated in sections 568(1)-(1A))?

The first instance judge was of the view that the effect of a disclaimer (as opposed to the mere act of disclaiming) can be inherently limited by other legal regimes, such as property law. Davies J held that a landlord can disclaim a lease, but that does not affect the tenant's leasehold interest in the land which was created when the lease was executed:

"As the tenant’s leasehold interest is the property of the tenant, a disclaimer of the lease by the liquidator of the landlord would only terminate the rights, interests, liabilities and property of the landlord but it would not bring the lease to an end for all purposes. Specifically, it would not bring the tenant’s proprietary interest in the land to an end. The tenant’s proprietary rights in the land will continue to subsist, even though the effect of disclaimer is that the landlord’s interests and liabilities under the lease have been terminated. Thus the effect of disclaimer is different where the lease is disclaimed by the liquidator of the landlord."

Her Honour further 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.[4]

At a very technical level, it should be noted that this was not a finding that the liquidator of a landlord cannot disclaim a lease. Rather, the Victorian Supreme Court held that the effect of such a disclaimer was very limited.

The Court of Appeal, by contrast, held that the tenant's interest in the leased land cannot survive the termination of the contract (the lease) which creates the tenant's interest. In the joint opinion of Warren CJ and Sifris J [at 39] "…any leasehold interest is governed by the contract of lease. It is the contract that regulates the substance and termination of the leasehold interest" noting that, in a change from the previous position and in "recognition that modern commercial leases, with extensive contractual provisions, stand in stark contrast to a long term lease of agricultural land at Blackacre at minimal or no rent"[5], the authorities support the proposition that any leasehold interest is governed by the law of contract. The Court of Appeal referred to Mason J's statement in the High Court decision in Progressive Mailing House Proprietary Limited v Tabali Proprietary Limited[6], that (following his review of the authorities):

"Accordingly, the balance of authority here as well as overseas, and the reasons on which it is based, support the proposition that the ordinary principles of contract law, including that of termination for repudiation or fundamental breach, apply to leases."[7]

The Court of Appeal held that, contrary to the findings of Davies J at first instance, the landlord's covenant to provide the lessee with possession and quiet enjoyment is an ongoing obligation (which has not accrued or vested) which obligation continues for the duration of the lease. It was thus necessary to affect the lessee's rights in order to release the landlord from liability.

The Court reinforced this reasoning by invoking the policy underlying the liquidator's statutory power to disclaim:

"Section 568D(1) allows the liquidator to terminate this obligation or liability despite its intrusion into the property rights of an innocent 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."[8]

Liquidators may welcome this development, and in particular the judicial affirmation of the policy reasoning behind it, but, as explored below, they should not read the Court of Appeal's words too literally.

A further word of caution arises from the fact that the Court of Appeal decision may not be the end of the matter. On 26 September 2012, an application for special leave to appeal to the High Court was filed by the respondent investors in the schemes. At the time of writing, that application has not yet been heard.

What is unprofitable?

Although emphasising the policy reasoning behind section 568D(1), the Court of Appeal clearly did not intend to say that section 568D allows a liquidator to disclaim all of the company's obligations so that the company "can be wound up without delay for the benefit of its creditors". The apparent breadth of the Court of Appeal's statement must be read subject to the overarching statutory requirement that the contract or property being disclaimed must satisfy the requirements in section 568(1) – (1A). In the case of contracts, a liquidator may not disclaim a contract without leave of the Court unless the contract is a lease of land or "unprofitable". The Court of Appeal in Willmott summarised this last requirement as referring to "ongoing liabilities which would prolong the administration and delay the dividend to creditors".[9] A more detailed explanation can be found in the main authority relied upon by the Court of Appeal:

  • "A contract is unprofitable for the purpose of s 568 if it imposes on the company continuing financial obligations which may be regarded as detrimental to the creditors, which presumably means that the contract confers no sufficient reciprocal benefit.
  • Before a contract may be unprofitable for the purposes of the section it must give rise to prospective liabilities.
  • Contracts which will delay the winding-up of the company's affairs because they are to be performed over a substantial period of time and will involve expenditure that may not be recovered are unprofitable.
  • No case has decided that a contract is unprofitable merely because it is financially disadvantageous. The cases focus upon the nature and cause of the disadvantage.
  • A contract is not unprofitable merely because the company could have made or could make a better bargain."[10]

The principles set out above illustrate that we are far from having a bright line test to determine when a contract is "unprofitable". Given that, it is interesting to speculate how many unilateral disclaimers by liquidators (that is, without the leave of the Court) would actually satisfy the "unprofitable" requirement were the disclaimer to be challenged in court.

Some liquidators may respond that this is just idle speculation. The only effect of disclaimer on the counterparty is to convert its contractual rights into a right to prove as an unsecured creditor. Where the company is hopelessly insolvent, there is likely to be little net practical difference between the counterparty's right to receive payments under a contract and a right to prove for its loss – and hence little incentive for the counterparty to launch a Court challenge to the disclaimer (other than as commercial leverage to attempt to improve its position).

Who is affected?

The operation of section 568B(3) demands “…a comparison between the position of the person who will lose if the disclaimer is not set aside and that of the other person who will lose if it is. Only if the prejudice to the former is ‘grossly out of proportion’ to the prejudice of the latter will the court be authorised to set the disclaimer aside.”[11]

As Global Television demonstrates, disclaimers can affect more than just the parties to the contract. In that case, the counterparty commenced proceedings against the liquidator in order to protect its rights against the guarantor of the company's obligation. It was concerned that, as well as terminating the company's obligations under the contract, the disclaimer rendered the guarantee ineffective. To that end, it argued:

(a) that the guarantee was not dependent upon the continued existence of the contract; or, alternatively, that

(b) if the guarantee was dependent upon the continued operation of the contract, the contract was not unprofitable, such that the liquidator was not entitled to disclaim it.

Santow J noted that, since the mid-1990s, the law has been that a guarantee survives disclaimer "absent wording expressly to the contrary". The Court's task in this situation, therefore, is to examine the wording of the guarantee. In Global Television, a detailed analysis of the contract and the guarantee produced the conclusion that it fell squarely within the "default" position: that is, there was no explicit statement that the guarantee did not survive disclaimer.

The default negotiating position, one would assume, would be that a party to a contract who seeks to have its counterparty's obligations secured by a third party guarantee will endeavour to ensure that its security does not fall away if the counterparty goes into liquidation. Nonetheless, as a practical matter, in a large and complex contractual arrangement between two or more commercial entities on an equal footing, it can not be assumed that the negotiating process has produced that outcome. Moreover, although it was held in Global Television that a guarantee survives disclaimer "absent wording expressly to the contrary", the Court in that case held that the following words did not satisfy that requirement:

"[the guarantor] shall not be … liable under this Guarantee for any obligation that [the company] does not or would not have under the [main contract]".

Unsurprisingly, the guarantor argued that this was an express provision precluding liability in the event of disclaimer, since the effect of disclaimer would be that the company would not have any "obligation" under the main contract. This argument was dismissed by the Court on the basis that an analysis of other provisions of the guarantee showed that the provision was not intended to have the effect claimed by the guarantor.

What this demonstrates is that in any reasonably complex commercial agreement, arguments for both sides will be available and judicial determination may be the only way to produce a definitive ruling on which argument is upheld.

After Willmott

In a report dated July 2012, the Corporations and Markets Advisory Committee of the Australian Government noted that:

"Recent experience with the collapse of some agribusiness common enterprise schemes points to the possibility of confusion arising in attempting to untangle these arrangements, with a range of involved parties, including scheme members, each seeking to assert what they perceive to be their proprietary and other rights and attempting to determine the way forward, often in an environment of conflict and resort to litigation."[12]

As noted above, at the time of writing, Willmott is the subject of a potential application for special leave to appeal to the High Court.

Since being handed down, the Court of Appeal's decision has been cited in two court proceedings[13] and applied in Grant v Harlgate Pty Ltd.

Although Grant turned on its facts, it does highlight one important aspect of disclaimer insofar as it relates to real property. In Grant, a company contracted to sell a piece of real property. Before settlement could take place, the company went into liquidation and the liquidator disclaimed the sale contract. The purchaser responded by rescinding the contract for sale and demanding the return of the deposit she had paid to the vendor's agent. The purchaser cited Willmott in support of her position that the disclaimer and her rescission had terminated her interest in the property.

In response, the agent relied upon another line of authority to the effect that disclaimer of a contract for the sale of land does not divest the purchaser of any equitable interest that he or she may have had in the land.

The Court had no difficulty in accepting this proposition, but it noted that it was irrelevant in the circumstances:

"The liquidators disclaimed the contract on behalf of the company. Shortly thereafter, the [purchaser] accepted that the contract was at an end. Neither the [purchaser] not the vendor seek to assert the existence and enforceability against each other of any right said to exist at the time of the disclaimer."[14]

Notwithstanding the outcome in this instance, the case is a useful reminder that Willmott does not necessarily mean that disclaimer extinguishes all interests in real property. In Rothwells Ltd (in liqn) and Others v Spedley Securities Ltd (in liq)[15], Hodgson J held that a disclaimer cannot terminate obligations which have accrued in the past.

Where the company has executed a contract to sell land, the prevailing wisdom is that the purchaser obtains an equitable interest in the land. In Dekala Pty Ltd (in liq) v Perth Land & Leisure Ltd[16], Young J held that a disclaimer filed by a liquidator in respect of an unprofitable contract relating to the acquisition of land under Torrens System title does not divest the purchaser under that contract of any equitable interest that he may have in the subject land at the time of disclaimer (following Re Bastable; Ex parte The Trustee [1901] 2 KB 518 at 529 and Re Clark; Ex parte Kahlefeldt (1985) 13 FCR 106; 64 ALR 305 at 111 and 310).

Willmott is authority for the proposition that interests acquired under a lease are extinguished by disclaimer, but on the current state of the law it would seem that the same reasoning does not apply to equitable interests acquired under an uncompleted contract for sale of land. In Willmott, Warren CJ and Sifris AJA considered the cases of Re Bastable and Dekala to be distinguishable and of marginal relevance since they do not deal with leases. If disclaimer does not terminate the purchaser's equitable interest in the land, the efficacy of disclaimer will be considerably reduced.

Conclusion

A procedure which is followed on an almost daily basis, such as disclaimer, may appear to be straightforward and uncomplicated, and the Court of Appeal in Willmott may have put the lease disclaimer genie back in its bottle – for now. However, further judicial consideration of the disclaimer provisions can be expected, particularly in light of "recent experience with the collapse of some agribusiness common enterprise schemes…[and] the possibility of confusion arising in attempting to untangle these arrangements" as well as the recent introduction of section 568(1AA) (rendering PPSA retention of title property an exception to the genus of property which may be disclaimed by a liquidator pursuant to section 568(1)), which is, as yet, untested. Notwithstanding the historic origins of the legislation and regularity of its application, below even the most quotidian processes lies a complex and not entirely settled body of law.

 

This article was first published in the Australian Insolvency Journal [2013] Vol 25 Number 1, March 2013



[1] See Global Television Pty Ltd v Sports Vision Australia Pty Ltd (In Liq) [2000] NSWSC 960; (2000) 35 ACSR 484, where at [1], Santow J remarked upon the return to the "19th Century orthodoxy" in examining the intervening judicial treatment of the impact of a liquidator's disclaimer on guarantees.Back to article

[2] See sections 443B of the Act for administrators and 419A of the Act for receivers. Back to article

[3] Although it is noted that an application could be made under section 447A to achieve this effect (orders to this effect were recently obtained by the Voluntary Administrators of Gunns Plantations Ltd in the Supreme Court of Victoria (unreported at the time of writing)). Back to article

[4] Re Willmott Forests Ltd [2012] VSC 29 at [1], [3]–[4]. Back to article

[5] (2012) 91 ACSR 182; [2012] VSCA 202 at [41]. Back to article

[6] [1985] HCA 14; (1985) 157 CLR 17. Back to article

[7] [1985] HCA 14; (1985) 157 CLR 17, at [29] (Mason J); cited by Warren CJ and Sifris J in Willmott [2012] VSCA 202 at [43]. Back to article

[8] [2012] VSCA 202 at [58]. Back to article

[9] Ibid at [63], citing: Global Television Pty Ltd v Sports Vision Australia Pty Ltd (In Liq) [2000] NSWSC 960; (2000) 35 ACSR 484, 498 [65] (Santow J); approved by Spigelman CJ in Sims & Anor (as liquidators of Enron Australia Pty Ltd) v TXU Electricity Ltd [2005] NSWCA 12 at[16]–[18]. Back to article

[10] Global Television Pty Ltd v Sportsvision Australia Pty Ltd (in liq) (2000) 35 ACSR 484 at [62], citing Transmetro Corporation Ltd v Real Investments Pty Ltd (1999) 17 ACLC 1314, per Chesterman J at [21]. Back to article

[11] Transmetro (1999) 17 ACLC 1314, per Chesterman J at [29]-[30]. Back to article

[12] Corporations and Markets Advisory Committee, Managed Investments Schemes Report (July 2012) 10-11; cited by Judd J in Re Timbercorp Securities Ltd (Applications for the approval of compromises) [2012] VSC 590. Back to article

[13] Re Timbercorp Securities Ltd (Applications for the approval of compromises) [2012] VSC 590 at [106] and Grant v Harlgate Pty Ltd [2012] VSC 464 at [39]. Back to article

[14] Grant at [40]. Back to article

[15] (1990) 20 NSWLR 417 at [422]. Back to article

[16] (1987) 17 NSWLR 664; (1987) 12 ACLR 585. Back to article

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