FEDERAL COURT OF AUSTRALIA

Norman, in the matter of Forest Enterprises Australia Limited (Administrators Appointed) (Receivers & Managers Appointed) v FEA Plantations Ltd (Administrators Appointed) (Receivers Appointed) [2010] FCA 1444

IN THE MATTER OF FOREST ENTERPRISES AUSTRALIA LIMITED (ADMINISTRATORS APPOINTED) (RECEIVERS & MANAGERS APPOINTED) and TASMANIAN PLANTATION PTY LTD (SUBJECT TO DEED OF COMPANY ARRANGEMENT) (CONTROLLERS ACTING) and FEA CARBON PTY LTD (SUBJECT TO DEED OF COMPANY ARRANGEMENT) (RECEIVERS AND MANAGERS APPOINTED)

REASONS FOR JUDGMENT

Introduction

1    The receivers of the FEA group wish to terminate or forfeit leases granted by three group companies, Forest Enterprises Australia Ltd (FEA), Tasmanian Plantation Pty Ltd (Tasmanian Plantation) and FEA Carbon Pty Ltd (FEA Carbon), to another group company. There are, however, two problems. One is that the receivers are not sure which group company is the lessee of leases granted by Tasmanian Plantation and FEA Carbon. The lessee could be either FEA Plantations Ltd (FEAP) or FEA (which, if it is the lessee, subleased the land to FEAP). The other problem is that neither the administrators of FEAP (the responsible entity of managed investment schemes which conduct forestry operations on the leased land) nor the investors in the schemes (growers who have had granted to them subleases or other rights in respect of the leased land) want the leases terminated. Thus the receivers come to court to seek (1) a declaration that FEAP is the lessee and has repudiated or otherwise breached essential terms of the leases granted by Tasmanian Plantation, FEA and FEA Carbon; and (2) a direction that they would be justified in causing Tasmanian Plantation, FEA and FEA Carbon to accept the repudiations by FEAP of its obligations under the leases and terminate them or forfeit the leases.

2    The general background is well known. Much of it is set out in my reasons for judgment in Norman v FEA Plantation Ltd (admins apptd) (recs apptd) [2010] FCA 1274, which concerned whether the receivers could take steps to terminate leases that had been granted by third parties to companies in the FEA group (so-called “external leases”). The leases the subjects of this application were granted over land owned by a FEA group company and are referred to by the parties as “internal leases”. The receivers who bring this application were appointed by ANZ Fiduciary Services Pty Ltd, the security trustee for the ANZ and Commonwealth banks, to be the receivers and managers of FEA and FEA Carbon, the controllers of Tasmanian Plantation and the receivers of certain of FEAP’s assets (but not of scheme property). The banks hold security over the FEA group in respect of advances which exceed $220 million.

The lessee of land owned by FEA Carbon and Tasmanian Plantation

3    Logically, the place to begin is to establish the identity of the lessee of the land owned by Tasmanian Plantation and FEA Carbon. Is the lessee FEA, which subleased the land to FEAP, which then granted sub-subleases of woodlots to the investors/growers? Or, is the lessee FEAP which, in turn, subleased the woodlots to the investors/growers?

4    The FEA group established a managed investment scheme to conduct forestry operations in each of the years 1993 to 2000. Up to that point FEAP was not involved in the operations. In those years the land on which the schemes were conducted had been leased to FEA which had subleased woodlots to growers. FEAP only came into the picture in 2000. In that year, FEAP became the responsible entity both for the existing schemes (ie those established between 1993 and 1999) and for any new schemes.

5    The introduction of FEAP led to the execution on 30 June 2000 of what is styled the “Standard Head Lease”. The parties to the Standard Head Lease are Tasmanian Plantation as lessor and FEAP (then known as Tasforestry Ltd) as lessee. The Standard Head Lease was not intended to demise any particular parcel of land to the lessee. Rather, it was to be the repository of the terms which, subject to the approval by the respective boards of Tasmanian Plantation and FEAP, would govern the “anticipated leases between the Lessor and the Lessee in respect of all land owned by the Lessor to be used for Managed Investment Schemes conducted by the Lessee”: Recital D.

6    According to other recitals: Tasmanian Plantation was established for the purpose of holding land to be utilised in the managed investment schemes (Recital A); FEAP was the responsible entity of the Tasmanian Forest Trusts Nos 1-7 (the managed investment schemes established in the years 1993 to 1999) and the Tasmanian Forest Project 2000 (the most recently established managed investment scheme) and was expected to be the responsible entity of future forests projects (Recital B); and pursuant to the constitutions of each managed investment scheme (i) Tasmanian Plantation was to hold land and lease it to FEAP; (ii) FEAP was to sublease the land to growers who would pay fees to FEAP in order to engage in the business of forestry plantation; (iii) FEAP had the responsibility of engaging FEA to establish and maintain plantations on the leased land (Recital C). By cl 6, the term of any lease was to run from the date specified in the relevant act of adoption of a particular lease and would come to an end upon the final clear fall of the trees upon the land.

7    There was a change in the leasing structure in 2003. The change is reflected in a Head Lease dated 26 June 2003 made between Tasmanian Plantation as lessor and FEA as lessee. FEAP is also a party. The recitals record that: Tasmanian Plantation had been established “for the purpose of holding land in its capacity as trustee of the Tasmanian Plantation Unit Trust to be utilised in Managed Investment Schemes” (Recital A); the lessee is FEA (Recital B); by a lease dated 26 June 2002 between the same parties (described as the “Original Lease”), Tasmanian Plantation granted to FEAP a lease of land specified in an annexure to the lease (Recital D); by cl 4(9) of the Original Lease Tasmanian Plantation granted to the lessee (FEA) an option of renewing the term for a further 19 years (Recital E); the lessee (FEA) exercised its option to renew the lease and Tasmanian Plantation has agreed to enter into the Head Lease pursuant to that exercise of option (Recital F).

8    By the Head Lease FEA covenanted to pay the rent “without any deductions whatsoever”: cl 2(a). Tasmanian Plantation acknowledged that FEA had the right to use the land for the establishment of a plantation of trees and may clear and cultivate the land, plant, tend, grow, care for, harvest and sell any crop of trees on the land during the term of the lease and any extension of the term of the lease: cl 2(b). FEA agreed to observe and comply with all regulations, notices, orders and directions given by any statutory or public authority: cl 2(d). Tasmanian Plantation acknowledged that the land would be sublet to FEAP as responsible entity of the managed investment schemes and consented to each sublease to a grower as contemplated by the recitals: cl 2(h).

9    The Head Lease contains a forfeiture provision for the non-payment of rent: cl 4(a). If the rent is in arrears for 28 days the lessor may give 28 days notice requiring the breach to be remedied and, if not remedied, the lessor may determine the lease and re-enter. There is a proviso. Where a default in the payment of rent “arises due to the Lessee or FEAP going into voluntary administration, liquidation or receivership, the Lessor agrees not to take any action to terminate this Lease for a period of six months after the date of liquidation, administration or receivership, in order to allow the receiver, liquidator or administrator of the Lessee or FEAP an opportunity to bring the Rent payments up-to-date”.

10    The parties have not been able to locate the Original Lease. Mr Silvia, one of the administrators of FEAP, has an unexecuted “Head Lease” which he believes might be a copy of the Original Lease. But that appears not to be the case. First, the draft is between Tasmanian Plantation as lessor and FEA as lessee (Recitals A and B) whereas other recitals implicitly refer to FEAP (then called Ausforestry Ltd) as the lessee (eg Recitals C(ii), D and E). Second, while an option to renew is given to the lessee, it is to be found in cl 4(q) not cl 4(9) as is recorded in Recital E of the 2003 Head Lease. Thus, while the draft provides some support for the proposition that Tasmanian Plantation leased the land to FEA, not much can be made of the document.

11    It is also necessary to refer to a Deed of Variation made on 22 December 2009 between Tasmanian Plantation, FEAP and FEA. The purpose of this Deed is to record that the rent payable under earlier leases granted by Tasmanian Plantation to either FEA or FEAP was the then current annual open market rent, and that if the rent payable did not constitute the then current annual open market rent, the parties would not be required to make any adjustment to the rent paid. The earlier leases, and the rents payable under them, are set out in Annexure B to the deed. That annexure suggests that Tasmanian Plantation was the lessor and FEAP the lessee. But the recitals say something else. According to Recital D:

The parties acknowledge that the parties, or any combination of the parties, have entered into earlier leases under which the Land or parts of the Land have been leased by the Lessor to FEA or FEAP, or by FEA to FEAP, which earlier leases include, without limitation, the lease dated 30 June 2000 between the Lessor and FEAP, the lease dated 26 June 2003 between the parties hereto (the “2003 Lease”), the Original Lease referred to in the Recitals of the 2003 Lease and any other lease, or sublease of the Land or parts of the Land entered between any combination of the parties which predate this lease including any equitable lease (the “Earlier Leases”).

12    Now, on this evidence the identity of the lessee from Tasmanian Plantation is not in doubt. Until 26 June 2003 the lessee was FEAP and on that day FEA was substituted as the new lessee.

13    The receivers contend that other evidence shows that the lessee of Tasmanian Plantation is FEAP. They also contend that there is evidence that the lessee of FEA Carbon is FEAP. First, there is the evidence of Ms Filgate, the property administrator of the FEA group. In that role Ms Filgate had become familiar with the structure and treatment of the internal leases. Ms Filgate says that despite the 2003 Master Head Lease referring to FEA as the lessee of the internal land:

(a)    at all times since at least March 2005, the FEA Group conducted its internal dealings on the basis that the Internal Land owned by Tasmanian Plantation was leased directly by Tasmanian Plantation to FEAP, and the leases were regulated on the terms set out in the Internal Lease Documents;

(b)    at all times since at least March 2005, the FEAP Group conducted its internal dealings on the basis that the Internal Land owned by FEA was leased directly to FEAP, and the leases were regulated on the same terms as the Internal Lease Documents; and

(c)    at all times since at least March 2005, the FEA Group conducted its internal dealings on the basis that the Internal Land owned by FEA Carbon was leased directly to FEAP, and the leases were regulated on the same terms as the Internal Lease Documents.

Ms Filgate has defined the “Internal Lease Documents” as comprising the 2000 Master Head Lease, the 2003 Master Head Lease and the Deed of Variation dated 22 December 2009. Ms Filgate acknowledges that “[i]n relation to the Internal Land owned by either FEA or FEA Carbon and leased to FEAP there is no specific lease documentation apart from the Internal Lease Documents” that identifies the tenant.

14    The next piece of evidence is from Mr Norman, one of the receivers. It is not direct evidence. Instead, it is based on what Mr Norman has been told by Mr Leicester who, until 31 August 2010, was the Chief Financial Officer of FEA and FEAP. According to Mr Norman, Mr Leicester told him that:

(a)    at all times since at least March 2005, the FEA Group conducted its internal dealings on the basis that the Internal Land owned by Tasmanian Plantation was leased directly by Tasmanian Plantation to FEAP, notwithstanding the description in the 2003 Master Head Lease of FEA as the lessee;

(b)    the relationship between Tasmanian Plantation and FEAP in relation to the Internal Land owned by Tasmanian Plantation and leased to FEAP was regulated on the terms set out in the Internal Lease Documents;

(c)    at all times since at least March 2005, the FEA Group conducted its internal dealings on the basis that the Internal Land owned by each of FEA and FEA Carbon was leased by each of those companies directly to FEAP; and

(d)    [Mr Leicester] is not aware of any separate documentation in relation to the Internal Land owned by either FEA or FEA Carbon and leased to FEAP.

15    Mr Norman also says that, according to the financial records in his possession, before FEAP was placed into administration it paid rent by book entry to the relevant landowning company which has a corresponding entry as rental income. According to Mr Norman:

(a)    the ‘book entry’ payments, which were recorded in the loan accounts of FEA, were a convenient mechanism for payment, because separate loan accounts were not maintained between FEAP and each landowner;

(b)    FEA’s loan accounts showed rent paid by FEAP to FEA in respect of the Internal Land owned by FEA, and this was recorded in FEA’s profit and loss account;

(c)    FEA’s loan accounts were effectively used as a ‘clearing house’ for payments of rent by FEAP to Tasmanian Plantation and to FEA Carbon respectively, but those rent payments were not recorded in FEA’s profit and loss account; and

(d)    this was the practice of the FEA group at least since about March 2005.

16    Finally, there are the notes to the annual accounts of FEA for the financial years 2008 and 2009. According to note 39 to each set of accounts, Tasmanian Plantation leased land to FEA (there is no dispute that this is pre-1999 scheme land, to which this application does not relate), FEA leased land to FEAP, Tasmanian Plantation leased land to FEAP and FEA Carbon leased land to FEAP. This suggests that land was leased directly from FEA Carbon and Tasmanian Plantation to FEAP.

17    The extrinsic evidence is not all one way. For example, Mr Leicester has sworn an affidavit upon which the administrators rely. In that affidavit Mr Leicester says that it was his understanding that the internal land owned by Tasmanian Plantation was leased to FEA and in turn subleased to FEAP in accordance with the 2003 Master Head Lease. He also says he does not believe there was any agreement whereby FEA ceased to be in the leasing chain between FEAP and Tasmanian Plantation.

18    Referring to what Mr Norman said about the rental payments, Mr Leicester acknowledged that the payments made to discharge the obligations of FEAP to FEA were booked through the loan account between FEA and FEAP. He explained that the terms upon which FEA leased land from Tasmanian Plantation were identical to the terms upon which FEA subleased the land to FEAP. Thus he said FEA did not make any profit on the arrangements, the implication being that this is the reason FEA is not recorded as having received any rent from FEAP. Mr Leicester disagreed with Mr Norman’s conclusion that FEA’s accounts were used as a “clearing house”.

19    Mr Cannon, a director of FEA and chairman of FEA Plantation, also swore an affidavit that is relied upon by the administrators. Mr Cannon says there is no agreement by which FEA ceased to be the lessee of land owned by either Tasmanian Plantation or FEA Carbon. Mr Cannon said “as far as [he] was concerned, FEA remained the head tenant to FEAP throughout [the relevant] period. It is true that the rent paid by FEAP was exactly the same as the rent paid by FEA, so that FEA did not take any fee or otherwise make a profit out of the arrangement. At no stage did FEAP consent to a variation [of the leasing arrangements]”.

20    Neither Mr Leicester nor Mr Cannon was cross-examined on his affidavit. Thus which of Mr Leicester’s conflicting statements (ie what he allegedly told Mr Norman and what he says in his affidavit) is accurate is a matter that I cannot resolve. The extent to which Mr Cannon’s evidence is inconsistent with what is disclosed in the FEA and FEAP records must also remain unresolved. It is not appropriate to deal with these kinds of issues on what seem to be contradictory but untested assertions.

21    In this state of the evidence, I am compelled to reject the receivers’ submission that I should not rely on the written agreements to identify the lessee of Tasmanian Plantation. The only basis upon which I would ignore what those agreements show is if I were satisfied that (1) the agreements were a sham; (2) they were executed by the parties in error; or (3) there had been a novation, in the sense that the parties (Tasmanian Plantation, FEA and FEAP) agreed that FEA would cease to be the lessee on condition that its obligations were taken over by FEAP. The evidence falls a long way short of establishing any of these alternatives.

22    With respect to the land owned by FEA Carbon, there is insufficient evidence for me to conclude which of FEA and FEAP is the lessee. There are no lease agreements in evidence. The evidence of Ms Filgate, that the FEA Carbon leases “were regulated on the same terms as the Internal Lease Documents” (ie the Tasmanian Plantation documents), is simply an assertion by a non-lawyer. Mr Cannon said that there was “no agreement by which FEA ceased to be the lessee of land owned either by Tasmanian Plantation or FEA Carbon”. But, the evidence upon which this assertion is based has not been tendered. The annual reports refer to land leased between FEA Carbon and FEAP, as does Annexure B to the Deed of Variation. I have explained why I would not rely on this evidence in respect of the Tasmanian Plantation land. It may be that these documents also inaccurately record the arrangements concerning the FEA Carbon land (ie the annual report and Annexure B to the Deed of Variation may refer to the way in which FEA conducted its internal dealings rather than the legal form of those arrangements).

Termination of the FEA-FEAP leases and the FEA-FEAP subleases

23    Having established that FEA is the tenant of Tasmanian Plantation and that FEA sublet the Tasmanian Plantation land to FEAP, it is now possible to consider whether the receivers would be acting appropriately by procuring FEA to terminate the leases granted to FEAP in respect of the land owned by FEA and by procuring FEA to terminate the subleases it has granted to FEAP in respect of the land owned by Tasmanian Plantation. For convenience I will refer to the leases and subleases collectively as “leases” because the same arguments apply to each. I must consider the bases upon which the receivers allege that FEAP has repudiated the leases. The first is the failure of FEAP’s administrators to confirm that FEAP is bound by the leases, and in particular that FEAP will comply with all regulations, notices, etc given by any statutory or public authority. The second is that FEAP has failed to pay rent. The final basis is that FEAP has demonstrated an incapacity to comply with the terms of the leases.

Failure to confirm obligations

24    I can dispose of this point quite quickly. In several letters written by the receivers’ solicitors, Maddocks, the administrators were requested to confirm whether FEAP would meet its obligations under the leases. FEAP, through its solicitors, avoided giving a direct response. In their 24 June 2010 letter FEAP’s solicitors, DLA Phillips Fox, said that certain of the obligations (eg taking steps to minimise the risk of bush fire) are “a liability of each of the Schemes not of FEAP itself”. That proposition is of course simply incorrect. In their 13 July 2010 letter DLA Phillips Fox requested Maddocks to identify “who is asserting a right as landlord in relation to each [of the leased] propert[ies]”. On yet another occasion a request for confirmation that the obligations would be met was simply ignored.

25    The receivers acknowledge that to establish that a party has repudiated a contract it must be shown that the party has indicated that it will no longer be bound by the contract – ie that it is not ready and willing to, or will not at the appropriate time, perform its obligations. I do not treat DLA Phillips Fox’s responses as unequivocally asserting that FEAP would not perform its obligations under the leases. As I read what DLA Phillips Fox said, they were, on one view, simply buying time but, on the most likely view, were making sure that nothing said would render the administrators personally responsible for the covenants imposed upon FEAP. But even if the firm’s responses amounted to prevarication, that prevarication could not properly be characterised as a repudiation by FEAP.

Non-payment of rent

26    Having got that point out of the way I can deal with the failure to pay rent. Here there is a preliminary issue, namely whether there is any rent outstanding. Mr Norman states that as at 14 October 2010 FEAP owed $4,074,709 in respect of the land owned by Tasmanian Plantation and $55,397 in respect of the land owned by FEA. Based on my conclusion that FEA is the lessee of the land owned by Tasmanian Plantations, FEA is owed approximately $4.1 million by FEAP (as at 14 October 2010).

27    But FEAP asserts it has a right of set-off against the rent an amount which exceeds the rent. The amount is $11 million which it is alleged FEA owes to FEAP.

28    FEAP’s claim for $11 million comes about in the following way. FEAP holds an Australian financial services licence issued pursuant to s 913B of the Corporations Act 2001 (Cth). The licence authorises FEAP to carry on a financial services business to provide general financial product advice for interests in managed investments schemes, to deal in managed investment scheme products and to operate managed investment schemes. It is a condition of the licence that FEAP must meet what is referred to as the “cash needs requirement”: licence condition 8. A licensee meets the “cash needs requirement” by complying with 1 of 5 options, each of which is described in the licence. Each option is designed to ensure that the licensee has the capacity to meet its financial obligations.

29    Option 1 is referred to as the “reasonable estimate projection plus cash buffer” option. To comply with this option, the licensee must, in broad outline, maintain cash flow projections for the ensuing three months and hold in “cash” 20% of the amount of its expected outgoings for that three month period. “Cash” must be represented by either assets which can be converted to actual cash within 5 business days or by a commitment (an “eligible undertaking”) to provide cash from an “eligible provider” which can be drawn on within 5 business days.

30    ASIC has published a regulatory guide (RG 166) which sets out the financial requirements that must be met by the holder of an Australian financial services license. RG 166 explains how a licensee can meet the “cash needs requirement”. For that purpose the guide defines “eligible provider” to include an ASX listed company whose net tangible assets exceed $50 million (RG166.185(b)(ii)) and “eligible undertaking” to mean a commitment that “(a) is an enforceable and unqualified obligation; and remains operative … until [ASIC] consents in writing to the cancellation of the undertaking” (RG166.189).

31    FEAP always satisfied the cash needs requirement by relying on Option 1. It chose to continue with that position in 2009. In early August 2009, Blake Dawson, the solicitors for FEAP, were requested to document a commitment from FEA to FEAP to satisfy the cash needs requirement. The commitment was provided on 27 August 2009 in the form of a letter from FEA to FEAP headed “Commitment to provide financial resources”. The relevant parts of the commitment letter read:

As Forest Enterprises Australia Limited (FEA) is an ASX listed company with net assets (excluding intangible assets) of $228 Million (as shown in the most recent audited financial statements lodged with the Australian Securities and Investments Commission), FEA qualifies as an “eligible provider”.

FEA hereby agrees to provide this commitment to FEA Plantation and in doing so, agrees to provide FEA Plantation with sufficient cash to meet its ongoing financial obligations and to satisfy its cash needs requirements from time to time.

In accordance with RG 166, requests for provision of funds by FEA Plantation will be honoured by FEA within five business days of receipt of a request from FEA Plantation.

However, the maximum amount which FEA agrees to provide FEA Plantation by way of a cash commitment in any calendar month is $5.5 Million. If FEA Plantation requires additional funds, then it can lodge a special request with FEA for these additional funds. FEA can, in its absolute discretion, provide the additional funds or deny the request.

This commitment is ongoing. However, FEA may withdraw this commitment at any time by providing FEA Plantation with one month’s written notice of termination of this commitment.

32    I observe that the commitment letter did not satisfy the requirements in RG 166 as it was capable of being withdrawn by FEA on one month’s notice. Under the guide such a commitment is required to remain in force until ASIC agrees to its withdrawal.

33    On 29 April 2010, FEAP’s solicitors wrote to FEA requesting that, pursuant to the commitment letter, it provide FEAP with $5.5 million for the month of April 2010 to enable FEAP to meet its financial obligations. The letter asked that payment be made within five business days. No payment was forthcoming.

34    On 5 May 2010, FEAP’s solicitors wrote to FEA requiring it to provide a further $5.5 million for the month of May 2010 to enable FEAP to meet its obligations. FEA did not provide the money. Instead, its solicitors wrote that the commitment letter was “not enforceable against FEA for a range of reasons, including (without limitation) lack of consideration”. They went on to state that “without prejudice … and out of an abundance of caution, FEA hereby gives one month’s written notice of termination of any commitment contained in that letter”.

35    Now, the claimed debt to FEAP and the claimed right of set-off gives rise to several questions. In summary, they are: (1) Is it the case, as FEA contends, that the letter of commitment is not binding?; (2) If it is binding, is ASIC’s consent required before FEA can terminate its commitment?; and (3) Can FEAP set-off money owed to it by FEA against the rent due to FEA?

36    As to (1), having regard to the history that led to the giving of the commitment letter there can be no doubt that, until it is withdrawn, it was intended to, and did, create a binding obligation on the part of FEA to provide funds to FEAP to enable FEAP to meet its financial obligations.

37    The want of consideration point raised by FEA is not without interest. In this case it is solved by the decision of the Victorian Court of Appeal in Atco Controls Pty Ltd (in liq) v Newtronics Pty Ltd (recs and mgrs apptd) (in liq) (2009) 78 ASCR 375. The principle I extract from that case is that if, on the request of a parent company, a subsidiary continues to trade, provided it obtains a letter of support from the parent there is consideration for the promises given in the letter of support.

38    Although the evidence on this aspect is limited (ie there was no direct evidence on the issue, explicable by the fact that the relevant companies are under the control of receivers and administrators) it is possible to infer that the request for the commitment letter was premised on the proposition that, without it, FEAP would no longer act as responsible entity. That inference may be made because, in the absence of the commitment letter, FEAP could not, consistently with its licence conditions, act as responsible entity of the schemes.

39    As to (2), I have already observed that RG 166 requires the “eligible provider” commitment to remain in force until ASIC gives its permission for the commitment to be withdrawn. But that is not what the commitment letter says. The letter provides that FEA can withdraw its obligations on one month’s notice. RG 166 cannot alter the nature of the arrangement. It only indicates that the arrangement was non-conforming, placing FEAP in breach of its licence conditions.

40    The answers to questions (1) and (2) produce the conclusion that FEA is indebted to FEAP in the amount of $11 million.

41    Question (3) is whether that debt can be applied to discharge the rent due the other way. That raises two further issues: (1) Generally, can a tenant set-off a cross-debt against rent?; and (2) Can a tenant set-off a cross demand against rent where, as here, the Head Lease provides that the rent is to be paid “without any deductions whatsoever”?

42    Concerning the first issue it has been accepted, at least since the decision in British Anzari (Felixstowe) Ltd v International Marine Management (UK) Ltd [1980] 1 QB 137, that it is possible in equity to set-off a cross-demand against rent. The set-off, once exercised, has the effect in equity of extinguishing the obligation to pay rent: Re KL Tractors [1954] VLR 505, 507. It is not every cross-debt that can be applied to reduce or eliminate the obligation to pay the rent. The qualification that Forbes J put on the equitable right (at 152) is that “the equity must impeach the title to the legal demand, or in other words go to the very foundation of the landlord’s claim. This seems to me to involve consideration of the proposition that the tenant’s cross-claim must at least arise under the lease itself, or directly from the relationship of landlord and tenant created by the lease”. Hence, Forbes J said (at 156), having regard to the tests of the case before him, that it would be manifestly unjust to allow the landlord to recover the rent without making an allowance for the damage the tenant had suffered because the landlord, in breach of the lease, failed to make good certain defects.

43    At the heart of the ability to set-off in equity is the requirement that the title to the plaintiff’s legal demand must be “impeached”: Rawson v Samuel (1841) Cr & Ph 161; 41 ER 451. And, as Gummow J made plain in James v Commonwealth Bank of Australia (1992) 37 FCR 445, 458, “the requirement of ‘impeachment’ and the phrase ‘title to the legal demand’ have not been narrowly construed”.

44    Most usually, those requirements will be satisfied if the cross-claim arises out of the transaction which gives rise to the debt. The failure to show such a connection led to the refusal of set-off in Eagle Star Nominees Ltd v Merril [1982] VR 557. On the other hand, in Popular Homes Ltd v Circuit Developments Ltd [1979] 2 NZLR 642, the plaintiff claimed damages due under a building contract. The plaintiff had originally agreed to build five houses for the first defendant. The parties then agreed that the plaintiff would purchase the land, paying only a small deposit up front, with the first defendant taking a mortgage over the property. To enable the plaintiff to carry out the work the first defendant advanced finance to the plaintiff and agreed to make progress payments. The first defendant defaulted on the progress payments and the plaintiff was unable to complete the project and repay the mortgage. The plaintiff claimed damages for breach of contract and a right to set-off any damages awarded against the amount secured by the mortgage. The first defendant claimed repayment of the mortgage money. The judge found that the failure to provide finance was a direct cause of the plaintiff’s inability to complete the project. He said, therefore, that the plaintiff could set-off against the debt due the quantum of its losses because the defendant could enforce the mortgage.

45    Applying the foregoing principles, the inescapable conclusion is that the relevant impeachment exists here. While the respective transactions do not arise out of the same (ie single) transaction they are so closely related that the transactions can properly be seen as one. The stated purpose of the commitment letter is to enable FEAP to meet its financial obligations. No doubt its largest obligation (or at least its largest recurring obligation) is to pay rent. The consequence of the breach of the commitment undertaking is that FEAP has failed to pay its rent.

46    The second issue is controversial. It has long been accepted that the right of set-off may be excluded by contract: Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689, 723. All that is required is for the parties to exclude the right in clear terms or by clear implication. The controversial aspect is whether equitable set-off is excluded when, in a case such as this, the lease provides that the rent is to be paid “without any deductions whatsoever”. There is a line of cases, beginning with Connaught Restaurants Ltd v Indoor Leisure Ltd [1994] 1 WLR 501, which hold that a “without any deduction” provision in a lease will not exclude equitable set-off because it is insufficiently clear to achieve that result. The same view was reached by the Court of Appeal in New Zealand in Grant v NZMC Ltd [1989] 1 NZLR 8. In those cases, the covenant to pay rent “without any deduction” was said to be limited to situations such as where the landlord is bound to make repairs and the tenant is forced to incur the expense him/herself. Then the tenant can reduce the rent by the amount of the expense incurred.

47    There are, however, other cases where a “without deduction” covenant has been held sufficient to exclude set-off. Most of the cases are referred to in a recent decision of the Supreme Court of Western Australia, Sander Benk Holdings Pty Ltd v Durkan [2010] WASCA 122. The cases include: Citibank Pty Ltd v Simon Fredericks Pty Ltd [1993] 2 VR 168; Debonair Nominees Pty Ltd v J & K Berry Nominees Pty Ltd (2000) 77 SASR 261; and Batiste v Lennon (2002) BPR 19,441. The judge was not called upon to resolve the divergent views. I do not have that luxury.

48    The approach I will apply (because it has been adopted by appellate courts) is that taken in Connaught Restaurants and Grant. According to those cases, where a provision in a lease requires the payment of rent “without any deduction”, the word “deduction” does not, in its natural sense, embrace a set-off conferred by operation of law. It is unlikely that the addition of the word “whatsoever” adds anything to a clause which stipulates that the payment of rent must be made without “any” deduction. More is required to exclude set-off. As Waite LJ put it in Connaught Restaurants (at 510), the word “deduction” may be used in its strict sense to describe the ordinary process of subtraction, or it may be used in a broader sense to describe the result which follows when one claim is set against another and a balance is struck. But, as clear words are necessary to exclude an equitable remedy, the word “deduction” in the lease was insufficiently clear to achieve that result. This approach has been adopted in Re Partnership Pacific Securities Ltd [1994] 1 Qd R 410 in preference to the broader view adopted in cases such as Citibank v Simon Fredericks. While I am following the path laid down by two appeal courts, I should make it plain that, if the issue was not covered by authority, I would likely reach a different conclusion.

49    The result of this discussion is that FEAP has a right to set-off against the rent it owes FEA the amount due to it under the letter of commitment, leaving FEAP with liability to FEA for rent in respect of the land owned by Tasmanian Plantation and FEA (as at 14 October 2010).

50    While the issue of whether non-payment of rent amounts to a repudiation now no longer arises, I should express my views in case I am wrong on the set-off point. It is not necessary in this connection to consider the effect of cl 4(c) of the Head Lease which imposes on the landlord a six-month moratorium. The clause need not be considered because the moratorium period has passed.

51    I observed in Silvia v FEA Carbon Pty Ltd (admins apptd) (recs and mgrs apptd) (2010) 185 FCR 301, [20], that the result of cases such as Shevill v Builders Licensing Board (1982) 149 CLR 620 and Progressive Mailing House Pty Ltd v Tabali Pty Ltd (1985) 157 CLR 17, is that the common law principles of termination for repudiation apply to leases. Authorities such as Total Oil Great Britain Ltd v Thompson Garages (Biggin Hill) Ltd [1972] 1 QB 318, which took a contrary position, are no longer good law. The point, then, boils down to this: FEAP has not paid the rent due to FEA for the months of May-September 2010 (inclusive), and assuming no right of set-off, FEA was owed approximately $4.1 million as at 14 October 2010. Does the failure to pay rent constitute repudiation, in the sense that FEAP has made it plain that it will not perform its contractual obligations? Or, to put the matter the way, as it was put by Deane and Dawson JJ in Laurinda Pty Ltd v Capalaba Park Shopping Centre Pty Ltd (1989) 166 CLR 623, 658, would FEAP’s conduct, when viewed objectively, convey to a reasonable person in the situation of FEA that FEAP has disavowed the leases? When put this way, the answer must, on balance, be in the negative. For one thing, as Mason J made plain in Progressive Mailing House at 34, the mere non-payment of rent (in that case for four or five months) is rarely sufficient to found a repudiation. In Progressive Mailing House, the tenant had repudiated its lease because, in addition to the non-payment of rent, the tenant had committed many other breaches of the lease. Other breaches of the leases have not been demonstrated here. Put another way, the non-payment of rent for a period of approximately five months in this case does not admit of the conclusion that FEAP is “guilty of such default in performance that the breach went so much to the root of the contract that it made commercial performance of it impossible”: Progressive Mailing House at 33 per Mason J.

Incapacity to comply

52    The third and final basis upon which the receivers claim that FEAP has repudiated the leases is that FEAP has demonstrated that it is unable to meet its obligations under the leases. A repudiation based on the inability of a party to perform is the most difficult category of repudiation to prove. It is true that in Universal Cargo Carriers Corp v Citati [1957] 2 QB 401 Devlin J said (at 437) that “a profession by words or conduct of inability is by itself enough to constitute renunciation”. But what must be established is that the promisor is “wholly and finally disabled” from performing the contract: British & Beningtons Ltd v North Western Cachar Tea Co Ltd [1923] AC 48, 72. This inability cannot easily be inferred and it must be proven to exist on the balance of probabilities. The receivers did not tender evidence which established disablement on the part of FEAP and so cannot make out the claim. In any event, Mr Silvia has said that it is possible the managed investment schemes will be restructured and, if that occurs, the outstanding rent will be paid. Further still, if FEA pays to FEAP the amount of money it still owes, FEAP will likely be in funds to pay the rent for some months to come.

The land owned by FEA Carbon

53    To this point there has been no mention of whether there has been a repudiation of the leases in respect of the land owned by FEA Carbon. As explained it is not possible to determine whether FEA Carbon leased its land to FEAP or FEA (which, if it is the lessee, subleased the land to FEAP). It goes without saying that if FEA Carbon leased land to FEA then the analysis regarding whether FEAP has repudiated its sub-leases in respect of the land owned by Tasmanian Plantation and FEA holds true in relation to the $13,625 of rent for May to September 2010 (inclusive) that FEAP owes in respect of the FEA Carbon land (as at 14 October 2010). If FEA Carbon leased land directly to FEAP then FEAP will not be entitled to set-off FEA Carbon’s claim to rent against the debt due from FEA to FEAP. While it may be accepted that mutuality is not a requirement of equitable set-off, it is impossible to see how the doctrine could operate to enable FEAP to set-off what it is owed by FEA against the debt due to FEA Carbon. A right of set-off might exist if there was an agency relationship between FEA and FEA Carbon (see eg Fuller v Happy Shopper Markets Ltd [2001] 1 WLR 1681) but here no relationship of agency is alleged.

54    Unless the receivers can do better with their investigation of the leasing arrangements concerning FEA Carbon, they are best advised to assume that FEA Carbon’s arrangements mirror the Tasmanian Plantation arrangements.

Conclusion

55    For the foregoing reasons I will not make a declaration that FEAP is the lessee of Tasmanian Plantation and FEA Carbon but, if requested by the receivers, I will declare that FEA is the lessee of the Tasmanian Plantation land. As well I will declare that FEAP is the lessee of FEA in respect of the land owned by FEA. I will not direct that the receivers are justified in causing Tasmanian Plantation to accept any repudiation by FEAP of its obligations under the leases for I have found there to be no repudiation. But, if requested, I will make a direction that the receivers are justified in causing FEA to exercise whatever rights they have under their leases with FEAP based on FEAP’s failure to pay rent. I will allow the receivers a short time within which to formulate appropriate orders.

Associate:

Dated:    21 December 2010

SCHEDULE OF PARTIES

TIMOTHY BRYCE NORMAN and SALVATORE ALGERI in their capacity as joint and several receivers and managers of FOREST ENTERPRISES AUSTRALIA LTD ACN 009 553 548 (ADMINISTRATORS APPOINTED) (RECEIVERS AND MANAGERS APPOINTED) and of FEA CARBON PTY LTD ACN 009 505 195 (SUBJECT TO DEED OF COMPANY ARRANGEMENT) (RECEIVERS AND MANAGERS APPOINTED) and TASMANIAN PLANTATION PTY LTD ACN 009 560 463 (SUBJECT TO DEED OF COMPANY ARRANGEMENT) (CONTROLLERS ACTING)

First and Second Plaintiffs

FOREST ENTERPRISES AUSTRALIA LTD A CN 009 553 548 (ADMINISTRATORS APPOINTED) (RECEIVERS AND MANAGERS APPOINTED)

Third Plaintiff

TASMANIAN PLANTATION PTY LTD ACN 009 560 463 (SUBJECT TO DEED OF COMPANY ARRANGEMENT) (CONTROLLERS ACTING)

Fourth Plaintiff

FEA CARBON PTY LTD ACN 009 505 195 (SUBJECT TO DEED OF COMPANY ARRANGEMENT) (RECEIVERS AND MANAGERS APPOINTED)

Fifth Plaintiff

FEA PLANTATIONS LIMITED ACN 055 969 429 (ADMINISTRATORS APPOINTED) (RECEIVERS APPOINTED)

First Defendant

FEA GROWERS GROUP INC. A0054610B

Second Defendant