13 Nov 2014

Landlords beware: lease incentive clawbacks impacted by Queensland Supreme Court penalties decision

by Tim Jones, Brian Noble, Anna Trevor

This case sends a clear message to landlords that incentive clawbacks are unlikely to be enforced.

The issue of whether payments under contractual provisions (whether the result of a breach or not) are penalties remains a hot topic since the significant High Court decision in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205.

A recent decision from the Supreme Court of Queensland has highlighted the potential danger of lease incentives and the assumption that incentives can be clawed back on specified events, including where the tenant does not complete the entire lease term.

In GWC Property Group Pty Ltd v Higginson [2014] QSC 264, the tenant, a law firm, had been granted a fitout incentive, together with rental and signage abatements.

A lease and incentive deed were entered into and the latter required the tenant to repay a proportion of the landlord's fitout contribution on the occurrence of certain events, including on termination of the lease for any reason. Similarly, the rental and signage abatement amounts had to be repaid in full if the lease was terminated by the landlord.

The tenant subsequently abandoned the premises, causing the landlord to terminate on the grounds of repudiation of the lease. The landlord then sought to claim the fitout incentive and abatement amounts from the tenant's guarantors (the first, second and third respondents), under the clawback provisions of the incentive deed.

Decision - clawback clauses found to be penalties

Justice Dalton of the Supreme Court found that the clawback provisions were penalties, and unenforceable given they were not a genuine pre-estimate of damage.

The Court found that the clause dealing with the repayment of the fitout contribution and the rent abatement and signage fees were penalties as the clauses stipulated that upon breach (or acceptance of breach resulting in termination) the tenant would pay an agreed sum for the fitout, rent abatement and signage fees.

The Court focused on the fact that had the tenant not breached the lease, the amounts would never have been payable. This meant that allowing the landlord's claim would confer on the landlord an advantage it would not have been entitled to, had the lease been fully performed. Accordingly, considered as matter of substance, the clawbacks operated as security for the tenant's completion of the lease term and the continued payment of rent.

For the same reasons, Justice Dalton found that the clawbacks were not a genuine pre-estimate of damage, as they imposed liability for payments the landlord was not entitled to, in addition to damages under the lease terms. As a result, the landlord was left to claim common law damages under the lease.

The messages for landlords

The enforceability of clawback provisions in incentive deeds was unclear prior to this case, although such terms are commonly included in commercial lease arrangements. This case sends a clear message to landlords that incentive clawbacks are unlikely to be enforced, and should cause landlords to reconsider the extent of the incentives offered and the mechanisms by which any are offered at the outset of lease negotiations.

GWC v Higginson also clarified some unresolved questions about how the penalties doctrine may apply to other clauses, in light of the High Court's expansion of the penalties doctrine in Andrews v ANZ.

In particular, Justice Dalton made it clear that following Andrews v ANZ, a clawback provision triggered by an event that was not a breach (such as assignment) would be open to the same finding, although she was not required to decide the point in this instance. Clawbacks that are triggered by assignment by the tenant are also common in commercial leases, and in light of the Court's comments these should be subject to further scrutiny by landlords.

More broadly, Justice Dalton noted that the Andrews v ANZ decision should be construed as marking a "more flexible approach to the law about penalties".

Finally, to the extent not already clear, GWC v Higginson confirmed that the penalties doctrine can't be avoided through separating out repayment obligations into an incentive deed (rather than including such provisions in the actual lease). As a commercial reality, a lease and incentive deed represent the combined terms of the bargain, meaning that any payment arising under the incentive deed for failure under a lease is open to interpretation as a penalty. In this case the fact that both the lease and the incentive deed were entered into at the same time by the same parties was further evidence the obligations imposed should be read together.

In many instances incentives comprise only a contribution to fit out costs whereas in this case the Court was considering obligations that were broader than just those in respect of such an incentive. It will be interesting to see whether this decision is endorsed by the courts when considering more specific incentive obligations.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.