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Property update: Tenant’s risks when a landlord is in liquidation

Dec 17, 2013

The High Court of Australia recently decided that when a landlord goes into liquidation, the liquidator may be able to disclaim a lease granted by the landlord.

For a tenant there can be very serious and very expensive consequences if a lease it has taken is disclaimed by its landlord’s liquidator.

A tenant may, however be able to take some steps to protect itself and avoid the expensive and significant consequences of a disclaimer of a lease by the landlord’s liquidator.

What does disclaim mean?

When a liquidator disclaims a lease, it means that the lease no longer exists.

This means that the tenant will lose all of the rights it had under the lease.

What are the consequences for tenants?

The lease will be at an end, meaning the tenant will need to either negotiate a new lease or find new premises.

Both of these outcomes can have costly and inconvenient impacts, such as:

  • A new lease negotiated following a disclaimer may be on less favourable terms than the previous lease;The rent may be higher or the lease may be for a shorter term, leading to uncertainty for the tenant;
  • Moving to a new premises can mean losing an existing local customer base;
  • The goodwill and reputation which has been built in the local area, a valuable commodity for many businesses, may also be lost;
  • Moving can mean losing an expensive fit out at the current premises;
  • It can also then involve expensive fit out work at the new premises to make them suitable for your business;
  • For some tenants, not having a secure lease could make it harder for them to raise finance for their business;
  • Where a tenant has used a lease as security for finance, disclaimer may trigger the lender to require repayment.

I am a lender and the lease is my security, what does disclaimer mean for me?

When a lease has been disclaimed, a lender who holds the lease as security for finance provided to the tenant will then lose that security.

This may mean that the lender may find it more difficult to recover from the tenant the funds advanced.

The security interest a lender has in a lease gives it similar rights to a tenant to take action to protect its interests when a liquidator intends to disclaim a lease (see below).

My landlord is in liquidation, will the liquidator disclaim my lease?

Not all leases will be disclaimed when a landlord goes into liquidation.

This will only happen in some situations where the lease makes the property more difficult for the liquidator to deal with.

A property may be difficult to sell or yield a lower sale price if the lease is unattractive to a prospective buyer.

The lease could impede sale for a number of reasons, such as;

  • The rent may be lower than market rent;
  • The lease may place obligations on the landlord, such as maintaining expensive plant and equipment or payment of a cash incentive to a tenant;
  • The landlord may have other significant obligations under the lease, such as renovation or rebuilding;
  • The lease term may be very long or give the tenant the option to extend for further terms which are considered unusually long;
  • The lease may adversely affect the value of the property as a site for redevelopment;
  • The lease may grant to the tenant an option to buy the property or grant right of first or last refusal to buy the property.

Can all landlords disclaim leases?

Where the landlord is a company which has gone into liquidation, the liquidator may be able to disclaim the lease.

Where the landlord is a natural person who becomes bankrupt, the trustee in bankruptcy may be able to disclaim the lease.

I am a tenant, what can I do?

A tenant can apply to the court to have the disclaimer stopped.

A liquidator must give a tenant written notice if he wants to disclaim the lease.

Once a tenant receives that notice, it has 14 days to make an application to the court to challenge the disclaimer.

Failure to make an application to challenge the disclaimer within that 14 day period will result in the disclaimer becoming effective, ending the lease.

The process is similar where the landlord is an individual who has become bankrupt, except the trustee in bankruptcy must give the tenant 28 days written notice.

The tenant then has 28 days to apply to the court to require the trustee in bankruptcy to seek permission of the court to disclaim the lease.

A tenant can still apply to the court to have the disclaimer set aside after it has taken effect.

Tenants should, however, be aware that once the disclaimer has become effective, an application to have it overturned will be much more expensive than challenging it before it becomes effective.

Additionally the likelihood of success is also much lower once the disclaimer is effective.

A tenants and a tenant’s creditor who hold security in respect of a lease, can seek damages for loss if a lease is disclaimed.

Those damages will, however, be an unsecured debt owed by the insolvent landlord. This means it is likely that, in most cases, only a small proportion of those damages will be recovered.

What will the court consider in making a decision on whether to allow a disclaimer?

In making a decision, the court will balance the rights of the tenant against those of the landlord’s unsecured creditors.

The court will aim to reach a decision which is just and equitable considering all of the circumstances.

To be successful, a tenant will have to show the court that it should exercise its discretion in favour of the tenant rather than in favour of a landlord’s unsecured creditors to stop the disclaimer. While this can be an onerous task it is not always insurmountable.

A tenant’s losses when a lease is disclaimed could include:

  • Costs incurred in moving;
  • Disruption of business, leading to loss of sales or other income;
  • The cost of carrying out works on a new property to meet a tenant’s business needs;
  • Higher rental outgoings at new premises where similar lease terms cannot be reached.

The court will review the tenant’s anticipated losses in light of the benefits for the landlord’s unsecured creditors if the lease is disclaimed.

Those benefits could be that the property can be sold more easily or for a higher price to pay back the landlord’s debt.

There is little case precedent in this regard to give guidance on how courts will weigh up the needs of both the tenant and the landlord’s unsecured creditors in order to make a decision.

It is certainly not as simple as adding up the financial benefits and losses of each party.

Are there any extra steps tenants and creditors can take to protect themselves?

Tenants who are not in physical possession of the property and lenders with security over the lease should make sure their interest in the lease is publicly recorded, by a caveat on the title, or possibly through registration on the Personal Property Securities Register.

A liquidator is obliged to notify interested parties of his intention to disclaim.

If the relevant interest is recorded on a public register a liquidator will be, or should be, aware of the interest and should therefore give notice to the interested party accordingly.

On the other hand if a relevant interest is not on a public record and is not apparent by inspection of the premises, because say the tenant is not in occupation of it, a liquidator is unlikely to give the required notice.

As a result the disclaimer may become effective before an interested party, (being a tenant or a tenant’s creditor holding security over the lease), learns that the lease has been disclaimed.

Tenants and lenders should also contact a liquidator as soon as they become aware that the landlord is in liquidation to ask if the liquidator intends to disclaim the lease.

A failure by the liquidator to respond within 28 days means the liquidator will not be able to disclaim the lease without leave of the court.

In seeking leave of the court a liquidator will have to notify the tenant and its secured creditor and each will have an opportunity to ask the court to prohibit a liquidator from disclaiming a lease.

Possible developments

The risk posed to parties with interests in a lease is likely to result in new agreements, probably in addition to a lease, being developed to protect those interests particularly when substantial amounts of money are at stake.

Those agreements could be made between a tenant, a landlord, a landlord’s mortgagee and a tenant’s mortgagee or some of them and would be designed to prevent or discourage a the mortgagee from proceeding with the liquidation of the landlord unless appropriate protection or compensation is given to the tenant or its creditor holding security over the lease, if the liquidator of the landlord disclaims the lease.

Solutions of these types are, however, unlikely to provide complete protection for parties with interests in a lease.

It certainly will be interesting to see the direction in which solutions are developed to resolve the problems that arise if a landlord’s liquidator disclaims a lease.

If you have any questions, please contact a member of our Property team on (03) 8600 8888.

Note: This update is a guide only and is not intended to constitute legal advice.