Court once again considers unenforceability of lease incentive clawbacks

Leighton Smith
13 May 2021
2.5 minutes
A recent Queensland District Court decision serves as a reminder of the importance of a cautious approach to incentive clauses.

The recent Queensland District Court decision in 148 Brunswick Street Pty Ltd v Strategix Training Group Pty Ltd [2021] QDC 38 reiterates the importance of adopting a careful approach when dealing with incentive deeds to avoid a situation which results in repayment of the incentive being construed as a "penalty" and therefore unenforceable.

Decision: the Andrews v ANZ test is still king

In Brunswick, an incentive deed was entered into by way of a lease variation. Under this deed, the landlord agreed to waive rent for the first 6 months, contribute $50,000 to the tenant's fit out and accepted a reduced rent for the balance of the lease term. The deed also gave the tenant the right to terminate the lease early within a prescribed period (effectively allowing the tenant to reduce the term from 5 ½ to 2 ½ years). This clause stipulated, however, that the tenant would be required to refund the value of the incentive if this right to terminate was exercised.

No decision was made on the merits of this case (as this was merely the hearing of an application for summary judgment). However, Judge Barlow's judgment provides a useful reminder as to how the Court will apply the test in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 to determine the enforceability of an incentive clawback clause. It also demonstrates that the Courts are open to interpreting such a clause as potentially not being a penalty where it gives rise to a further obligation or right.

The Court's method and what it means for landlords

This case is a reminder that:

  • there is no "one size fits all" approach to structuring an incentive clawback. The Court will always start by considering the circumstances in context. In offering an incentive, a landlord must consider their bargaining power, the losses that may reasonably accrue on default and the commercial context of the incentive;
  • even an event which does not constitute a breach may give rise to a penalty. It was noted that unenforceable penalties are generally "triggered", meaning they flow on from the occurrence of an event. In this case, the tenant exercising the right to reduce the term was argued to be the event which "triggered" the penalty;
  • generally, an incentive clawback will be an unenforceable penalty where the sum recoverable is greater than a genuine pre-estimate of damages. Again, the Courts have said that determining what is and is not a genuine pre-estimate requires case-by-case analysis. A sum will not normally be a genuine pre-estimate of damages where it is extravagant and unconscionable in comparison to the greatest loss which could conceivably be proven; and
  • the inclusion of repayment obligations in a separate incentive deed does not displace the penalties doctrine. The Court will consider the parties' bargain in totality. A clawback provision forming a penalty in a lease will still be considered an unenforceable penalty if present in an incentive deed instead.

The further obligation exception

Importantly though, the "further obligation" exception may apply to negate the argument that a certain obligation constitutes an unenforceable penalty. The Court may not consider a clawback to be a penalty where the relevant payment is in exchange for the acquisition of an additional right or obligation.

The argument in Brunswick was that the relevant clause operated to grant an option for the tenant to reduce the length of the lease in exchange for repayment of the incentives provided. Judge Barlow indicated that these were strong grounds for the Court to find that this clause was the result of a fairly negotiated, albeit harsh, enforceable commercial bargain. While a substantive judgment on this point was not reached, this discussion provides a good indication that landlords may be able to recover the incentives they offer where the clawback is reflective of the potential loss or in consideration for granting additional rights to the tenant.

Key takeaways

This case highlights the importance of careful drafting when it comes to incentives and clawbacks in leases. When offering an incentive, landlords should be aware that the full amount may not be properly recoverable upon the occurrence of default or another event triggered by the tenant.

If a Landlord does wish to maximise the possibility that an incentive will be recoverable, where applicable it may be preferable for the clause to be drafted so that any repayment is in consideration for a further right of the tenant or obligation of the Landlord.

Thanks to Eric Jeffery for his help in writing this article.

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