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 struck.

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.

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.