Australia: Lease incentive claw backs found to be a penalty

Last Updated: 14 November 2014
Article by Brian Smith


Lease incentives given by landlords to induce tenants to enter leases are a very common feature of the property landscape in Australia. These usually take the form of fit out contributions or rent abatements (or a combination of both). Frequently, the landlord requires the inclusion of a 'claw back' provision, so that if the lease is terminated, the tenant must repay to the landlord a pro rata part of the incentive (in addition to any other remedies which the landlord may have arising from the termination).

A recent decision of the Supreme Court of Queensland has cast considerable doubt over the enforceability of these claw backs.

The Decision

The facts in GWC Property Group Pty Ltd v Higginson and others [2014] QSC 264 are uncontroversial and quite commonly encountered.

In 2010, Hynes Lawyers Pty Ltd entered a lease of commercial office space in Brisbane for a term of seven years (plus options) at a commencing rent of AUD767,715 per annum. At the same time, it entered a separate incentive deed with the landlord under which the tenant was to be paid a very substantial fit out allowance and was given a rent abatement to apply during the first three years of the term. The tenant's obligations under the lease and deed were guaranteed by the directors of the tenant.

The incentive deed provided for claw back (on a pro rata basis) of the fit out incentive if the lease was terminated for any reason other than default by the lessor or if there was an unauthorised assignment or subletting. It also provided for claw back of the whole of the rent abatement amount if the lease was terminated by reason of the lessee's default.

The incentive deed did not contain any substantial obligations on the parties other than for payment, and repayment, of the incentives.

In 2013, the tenant abandoned the premises. The landlord accepted the tenant's repudiation and terminated the lease. The tenant went into liquidation and the landlord commenced proceedings against the guarantors under the incentive deed for recovery of the amounts due under the claw back provisions (approximately AUD1.2 million in total).

The guarantors resisted the proceedings on the basis that the claw back provisions amounted to penalties and were therefore unenforceable at common law.

Findings of the Court

The Court (Dalton J) found that:

  • the incentive deed and the lease are to be construed as if they were one document having been entered at the same time, between the same parties and dealing with the same subject matter
  • since the events triggering the obligation to repay the incentive amounts were based upon failure by the tenant to observe its primary obligations under the lease, the claw back provisions fell squarely within the description of what constitutes a potential penalty under the decision of the High Court in Andrews v ANZ Bank [2012] 247 CLR 205
  • having regard to the true nature of the bargain struck by the parties, it would be commercially artificial to characterise the incentive payments as being conditional payments and the claw back provisions as merely restitution because the conditions have not been met
  • the claw back provisions must accordingly be examined to see whether they are penalties (and therefore unenforceable) or pre-estimates of liquidated damages (and therefore enforceable)
  • the test of whether the claw back provisions are a penalty is if they require payments which are extravagant and unconscionable in comparison with the maximum loss that might be suffered arising from the tenant's breach and, in this context, the test is objective and not related to the state of mind of the parties
  • the claw back provisions are penalties as they impose obligations which are substantially in excess of any genuine pre-estimate of loss taking into account the extent of the damages which the landlord is entitled to recover at common law upon termination of the lease and that the claw back provisions would otherwise allow the landlord to recover additional amounts in excess of its actual loss
  • the claw back provisions are therefore unenforceable.

Impacts of the Decision

The decision may well have a significant impact. It is likely that most claw back provisions contained either in leases or in separate deeds will be unenforceable as penalties, as the provisions in this case are in a form which is widely used in the property industry throughout Australia. It is also difficult to envisage a way in which these types of provisions could be used which would avoid that outcome.

We are yet to see how this will play out over the longer term and whether, in particular, the inability to include enforceable claw back provisions will have any effect on the future structure of incentives and rental arrangements.

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.

K&L Gates has been awarded a 2012 EOWA Employer of Choice for Women citation acknowledging our commitment to workplace diversity.

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