Landlords beware — Incentive claw-back provisions deemed to be penalty clauses
The recent Supreme Court of Queensland decision of GWC Property Group Pty Ltd v Higginson & Ors affirms the long-held but (until now) untested fear that the ubiquitous claw-back provisions which accompany most incentive provisions may very well constitute a penalty clause.
What is a penalty provision?
The modern law of penalty provisions was enunciated in the UK House of Lords’ decision of Dunlop Pneumatic Tyre Co v New Garage & Motor Co Ltd, where Lord Dunedin stated that the following tests would determine whether a clause is a penalty:
- If a sum [recoverable] is extravagant or unconscionable in comparison with the greatest loss that could conceivably be proved to have followed from the breach;
- If a breach is a failure to pay a sum of money and the impugned clause stipulates an amount greater than that which ought to have been paid (other than interest); and
- Where a clause stipulates a sum payable on the occurrence of one or more events, some of which may occasion serious damage, but others merely trifling damage, there is a presumption (but no more) that the clause is a penalty.
This test was affirmed in Australia in the High Court decision of Ringrow Pty Ltd v BP Aust Pty Ltd where it was held by the Court that the law of penalties is attracted where “a contract stipulates that on breach the contract-breaker will pay an agreed sum which exceeds what can be regarded as a genuine pre-estimate of the damage likely to be caused by the breach” (at 663).
GWC Property Group Pty Ltd (Landlord) owned a property in Bowen Hills, Queensland which was leased by its predecessor in title to Hynes Lawyers Pty Ltd (Tenant) for a term of 7 years with three option periods. The Lease was entered into on 11 November 2010 and was accompanied by an Incentive Deed which was recited as being “intended to supplement the Lease”. It was noted that other than confidentiality provisions, the Incentive Deed contained no substantial primary obligations of the Tenant but rather obligations by which the Landlord must allow the Tenant the agreed incentives.
The Tenant abandoned the premises on 20 May 2013 in breach of the Lease. The Landlord accepted the repudiation of the Lease and terminated the Lease on 12 June 2013. The Tenant is now in liquidation.
The Tenant’s obligations under the Lease and Incentive Deed where guaranteed by the First, Second and Third defendants (Guarantors). It appears however, that the Guarantors were released from their obligations with respect to the Lease by the Landlord who agreed to accept a bank bond in satisfaction of securing the Guarantors’ obligations under the Lease. The Guarantor’s obligations with respect to the Incentive Deed were not released and that is the basis on which the Landlord sued the defendants, seeking $1.2 million as the amount of incentives which the Tenant received under the Incentive Deed.
The Incentive Deed provided for the following:
- fit-out contribution;
- rental abatement; and
- signage fee abatement.
The Incentive Deed also contained standard claw-back provisions with respect to the fit-out contribution and rental abatement which, in summary provided:
(a) [with respect to the fit-out contribution] if the Lease was terminated prior to the expiration of the initial term, the Tenant will pay the Landlord a sum calculated by multiplying the number of days between the date the Lease is terminated and the expiry date by the amount of the contribution, and divided by the number of days of the initial term; and
(b) [with respect to the rental abatement] if the Landlord terminates the Lease due to the Tenant’s default, the Landlord has against the Tenant a liquidated debt and the Tenant must pay the Rent Abatement Amount [as defined in the Incentive Deed] that has been abated by the Tenant.
The matter was brought before Her Honour Justice Dalton by application of the First, Second and Third Defendants for summary judgement.
Her Honour considered point 1 of Lord Dunedin’s test above, noting:
- Before the Lease and Incentive Deed were signed, the Landlord was in the position that the Tenant would only enter into the Lease and Incentive Deed on the basis it received the abatement and fit-out payment.
- By the bargain contained in the Lease and Incentive Deed, the Landlord obtained abated rent and fees in consideration for its lease of the premises, together with the fit-out payment.
- Had the Lease been performed according to its terms, the above is all the Landlord was entitled to.
- The claw-back provisions of the Incentive Deed sought to give the Landlord an advantage that it would not have had if the Lease was performed according to its terms and thus, would not restore the Landlord to the pre-contractual position by, in effect making the Landlord entitled to recover as though the Tenant had agreed to the rent and signage fees without any abatement.
In a somewhat stern rebuke, Her Honour noted that the situation in which the Landlord found itself was a result of its own commercial decisions and stated that the claw back provisions where wholly penal in their operation, providing for significant sums to be paid over and above damages which would be payable to the Landlord at Common Law.
The application was allowed for the First, Second and Third Defendants and the matter dismissed.
Does this affect you?
Until now, the application of claw-back provisions with respect to incentives had not been properly tested. This decision may pave the way for further challenges to claw-back provisions should a landlord seek to rely on them over and above the common law damages available in respect of a breach of a lease.
Going forward, careful consideration should be made when lease deals are incentivised, particularly with front-end rent free periods and a fit-out contribution, so that any claw-back provisions are not penal in nature.