10 November 2014
Lease Incentive Claw Backs Found to be a Penalty
Australia Real Estate Alert
Practice Group(s):
Real Estate
By Brian Smith
Introduction
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
Lease Incentive Claw Backs Found to be a Penalty
 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.
Authors:
Brian Smith
brian.smith@klgates.com
+61.7.3233.1227
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Lease Incentive Claw Backs Found to be a Penalty
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