A recent decision of the Victorian Civil and Administrative Tribunal (VCAT) has clarified the legal position in Victoria with respect to a landlord's ability to claw back a fit-out contribution paid to a tenant upon the early termination of a tenant's lease.
In 2014 in GWC Property Group Pty Ltd v Higginson & Ors  QSC 264 (Higginson), the Queensland Supreme Court held that repayment clauses contained in a fit-out incentive deed were "wholly penal in their operation: providing for significant sums to be paid over and above damages which would be payable to the landlord at common law".
The Higginson decision has now been applied in Victoria.
In Finetea Pty Ltd v Block Arcade Melbourne Pty Ltd (Building and Property)  VCAT 1529 (Finetea), VCAT considered a number of issues, including relevantly whether the landlord was able to recover the value of incentives totalling $555,000 given to Finetea Pty Ltd under the terms of a lease which had been terminated.
A clause contained in the lease provided that if the lease was terminated by the landlord as a result of the tenant's default, the tenant would be required to repay a proportion of the incentive to the landlord, calculated according to the unexpired term of the lease remaining.
Whilst the tenant commenced fitting out the premises, it failed to pay rent to the landlord and had not yet opened for trade when the lease was terminated by the landlord in June 2017. The tenant commenced proceedings in VCAT and the landlord filed a counterclaim in which it sought, amongst other things, an order that the tenant repay the incentives pursuant to the provisions of the lease.
The question for VCAT to consider was "whether the stipulated repayments (were) extravagant and unconscionable in comparison with the maximum loss that might be suffered by the Landlord from the breaches of the Lease alleged."
Senior Member Walker, in applying the decision in Higginson, held that:
"...in exchange for the incentive, the Landlord obtained the benefit of the Lease and a contractual right, after the rent-free period had expired, to receive rent and outgoings for the term of the Lease. That rent was struck in the expectation that the Basement and Shop 13 would be fitted out in the manner contemplated at the expense of both parties and then occupied by Finetea for the period of the Lease. Had Finetea not broken the Lease, it would not have been responsible for paying rent and outgoings for the rent-free period, nor would it have been responsible to repay to the Landlord its contribution towards the fit out. The rent-free incentive and the fit-out contribution were part of the consideration for its entry into the Lease.
Because of Finetea's breach, the Landlord has lost the benefit of the Lease. It is entitled to damages for the loss of the Lease. The Landlord now seeks an order that, in addition to those damages, it should receive back the value of these incentives. That is 'extravagant and unconscionable in amount' and out of all proportion to the damage it has suffered. To allow such a claim would be to enforce a penalty.
Further, to allow such a claim in addition to damages would be to order double recovery because the Landlord would be receiving both damages for what it has lost and also the price that it paid to acquire what it has lost. A clause designed to bring about such a result imposes a punishment for the breach and protects no legitimate interest."
As a result of the VCAT decision in Finetea, a landlord will not be permitted to recover incentives paid to tenants upon the early termination of a lease if the repayment provisions contained in a lease or fit-out contribution deed are "extravagant and unconscionable in comparison with the maximum loss that might be suffered by the landlord".
This is unlikely to be the end of the story for fit-out incentives, however. The courts and tribunals are yet to consider the potential loss to a landlord in having to provide further incentives to a subsequent tenant and how that may impact the overall benefit received by the landlord and therefore the overall loss claimable from the defaulting tenant.
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