In the recent decision of GWC Property Group Pty Ltd v Higginson & OR’s [2014] QSC 264, the Queensland Supreme Court held that the incentive clawback provisions contained in an incentive deed, which were triggered by the tenant’s breach of the lease, were unenforceable penalties.

The court refused to allow the landlord to make a windfall gain in excess of its loss of bargain arising from the tenant’s default. It held that that bargain was that the tenant would pay the abated prices for rent and signage fees on condition that the landlord paid for the fit-out.

In light of the decision, where a landlord’s claim for an incentive clawback does not represent a genuine pre-estimate of the landlord’s loss, there are grounds for resisting the claim; for example, if the claim is triggered by a change of control of the tenant arising from an M&A transaction.

Summary of facts

The Landlord owned office premises in Bowen Hills, Queensland. In November 2010, the Landlord’s predecessor in title entered into a lease of the premises with the Tenant for a term of seven years with three options. At the same time that the lease was entered into, the same parties entered into an incentive deed in relation to the premises. The following incentives were granted to the Tenant under the incentive deed:

  1. the Landlord would make a monetary contribution to the Tenant’s fit-out of the premises, which was calculated as an amount per square metre;
  2. the Tenant was granted a rental abatement for the first 3 years of the lease, which was payable in monthly instalments; and
  3. the Tenant was granted a signage fee abatement for the first 3 years of the lease. 

The Tenant abandoned the premises and the Landlord terminated the lease in June 2013. If the lease was terminated (other than by expiry of term or due to the Landlord’s default), then, under the incentive deed, the Tenant was required to repay to the Landlord a proportion of the Landlord’s contribution to the Tenant’s fitout as well as the rent and signage fee that had been abated to the Tenant up to the lease termination.

Four individual Guarantors had guaranteed the obligations of the Tenant under the lease and the incentive deed and the Landlord sued the Guarantors for the amount of incentives which the Tenant had failed to repay on termination of the lease. The Guarantors claimed that the clawback provisions were penalties and unenforceable.

Landlord’s arguments

The Landlord argued that, because the incentives were paid on condition, the termination of the lease activated the repayment condition and so, as a result, the repayments sought were not actually punitive payments on breach but in fact restitutionary payments.  Dalton J disagreed. Her view was that if the Tenant had not breached the lease to trigger the clawback provisions, then the Tenant would never have had to repay the incentives.   

The Landlord also argued that the incentive deed was to be looked at separately from the lease because the purpose of the incentive deed was to persuade the Tenant to enter into the lease. Dalton J rejected this. Her view was that the bargain between the parties was contained in both the lease and the incentive deed to be read together and the abated rent and signage fee was in consideration for the lease and the fit-out payment. The clawback provisions would not restore the Landlord to its pre-lease position, but rather, they gave the Landlord an advantage that it would not have received if the lease had been performed and run its term.

Decision

The law regards a clause as an unenforceable penalty if it requires a party which breaches a contract to pay an amount which is extravagant and unconscionable compared to the maximum loss that could be suffered by the other party.

For the clawback provisions to be penalties, the Guarantors therefore needed to show that the repayments were extravagant and unconscionable compared to the maximum loss that the Landlord might suffer for the Tenant’s breach.

Dalton J’s view was that the clawback provisions were substantially in excess of any genuine pre-estimate of damages. The Landlord’s evidence included that the incentives reflected prevailing market conditions and future tenants may not want the fit-out or may also require incentives. On this point, Dalton J’s view was that it was only with these financial concessions that the Landlord obtained the lease and so while the Landlord was entitled to damages for breach of the lease it was not entitled to extra payment on the basis that it might have obtained a higher rent if there had been better market conditions. Considering the Landlord’s damages, Dalton J found that under the incentive deed the Landlord would own the fitout and as a result, if the Landlord had difficulty in re-letting the premises due to the fitout in place any inability to re-let would be reflected in its contractual damages.

Dalton J held that on the facts of this case that there was no reason to doubt that common law damages would not be an adequate remedy and further that the clawback provisions operated to give the Landlord significant sums over and above damages which would be payable to the Landlord at common law. Dalton J found that:1

[b]efore the Lease and Incentive Deed were signed the landlord (Plaintiff) was in the position that its potential tenant would contract only on the basis that it received abatements and a fit-out. The impugned clauses do not restore the landlord to that pre-contractual position; they give it an advantage which it would never have had if the lease had uneventfully run its term.”

For these reasons, the clawback provisions were penalties.

What does this mean for landlords and tenants?

The inclusion of incentive clawback provisions is not uncommon in incentive deeds. However, in light of the decision in this case, it may now be difficult for a landlord to enforce such provisions if they do not represent a genuine pre-estimate of the landlord’s loss as they will likely be viewed as a penalty.

Importantly, Dalton J made it clear that following recent case law developments,2 a clawback provision triggered by an event that was not a breach of lease, such as an assignment of lease for example, would be open to the same finding, although she was not required to decide the point in this instance.