Commercial landlords should take heed of one of the latest
decisions from the High Court, which has implications for paying
incentives to tenants.
It means that landlords may want to consider the circumstances
in which incentive payments are refundable - so that if the
property is unable to be occupied before the lease commences, they
can receive a refund of any inducement paid.
In the recent High Court case, the parties entered a conditional
agreement to lease premises for 12 years The offices needed work,
and the agreement was conditional on agreeing terms for
refurbishment. In return for declaring the agreement unconditional,
the landlord agreed to pay an inducement of $260,000 plus GST to
the tenant. This reflected the estimated cost to the tenant of
completing the fit out. The agreement to lease became unconditional
in late 2010, with occupancy due to commence on 1 April 2011. The
tenant was permitted early entry to undertake the fit out and this
had been partially completed when the February 2011 earthquake
The earthquake left the building untenantable and it was
demolished in 2012. The landlord received an insurance pay-out
under its business interruption policy for loss of rent. The tenant
received the benefit of an insurance payment relating to most of
the fit out costs.
The landlord then went to Court to recover the inducement
payment it had made to the tenant. It argued that the consideration
for the inducement payment had failed, as the landlord had never
received the anticipated rent (other than a deposit that had been
paid) because the premises were destroyed. On that basis, the
landlord argued that the inducement payment should be returned by
The tenant did not see it that way. They claimed that they had
fulfilled their part of the deal by confirming the lease agreement
was unconditional, foregoing other lease options and incurring
expenses for the fit out. The Court agreed with the tenant. The
inducement payment was in exchange for declaring the agreement
unconditional, and it was the agreement that allowed the business
interruption insurance claim for loss of rent to be made by the
landlord. The Court recognised that the tenant would benefit from
the insurance received for the fit out, as well as being permitted
to keep the inducement, but the alternative was to allow the
landlord to have the refund of the inducement as well as the
business interruption insurance. Whichever way the Court decided,
there was an element of injustice and a windfall gain.
With the possibility of significant inducement payments being
made in the next few years, landlords should consider whether a
"claw-back" clause should be included in any lease
agreement in the event the building cannot be occupied.
Alternatively, there are other ways of structuring a lease
agreement that should provide the same benefits to the tenant but
which will give the landlord the protection needed against
unforeseen events. The issue is particularly acute given the
limited time during which business interruption cover is paid for
loss of rents. If a landlord has paid a large sum to a tenant in
exchange for a long term lease - but only receives a 12 month loss
of rent payment - they will be significantly out of pocket if the
premises become untenantable.
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.
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