The Facts
Tenant and landlord agree terms of lease and incentives
A law firm was negotiating with a landlord for the lease of office premises in the inner Brisbane suburb of Bowen Hills, in Queensland. In November 2010, the parties agreed a deal and the terms were recorded in two documents:
- A standard form lease for a term of seven years, with three options to renew. Rent was to be paid monthly and a signage fee was to be paid annually; and
- An incentive deed, by which the landlord offered several incentives to the law firm to secure the deal, including a contribution to the fit out of the offices and a three-year reduction in the rent and signage fees payable under the lease.
Three guarantors provide personal guarantees
Both documents contained personal guarantees provided by three guarantors, who guaranteed to the landlord that the law firm would meet its obligations.
The incentive deed also contained repayment clauses so that if the lease was terminated because of a default by the law firm, the landlord could claim back a proportion of the cost of the fit out as well as the amounts by which the rent and signage fees had been reduced.
Tenant abandons premises and landlord commences legal proceedings
In May 2013, the law firm tenant abandoned the premises in breach of the lease. The landlord accepted the repudiation of the lease by the tenant and terminated the lease.
The law firm went into liquidation and the landlord pursued the three guarantors for monies owed under the lease as well as under the repayment clauses of the incentive deed.
The guarantors refused to pay the amounts claimed by the landlord under the incentive deed (in the sum of around $1.2 million) and the landlord commenced proceedings in the Queensland Supreme Court.
It was up to the court to decide whether the repayment clauses in the incentive deed were enforceable or whether they amounted to penalties, in which case they would be unenforceable.
Expert commentary on the court's decision
Court finds that incentive repayments constitute a penalty and so are unenforceable
In GWC Property Group Pty Ltd v Higginson & Ors [2014] QSC 264, the court found that the landlord was not able to recover the incentives. The attempted recovery of the incentives by the landlord was a penalty.
The court agreed with the arguments for the guarantors (and, in effect, the tenant), that the repayment clauses imposed obligations which were substantially in excess of any genuine pre-estimate of damages.
The repayment clauses enabled the landlord to recover money to which it would never have been entitled if the lease had run its course. In effect, the clauses entitled the landlord to recover as though the tenant had agreed to the rent and signage fees without any abatement, and as though it had not been necessary for the landlord to pay the fit-out incentive in order to complete the bargain with the tenant.
As the judge noted, the situation in which the landlord found itself was a result of its own commercial decisions, adding: “There is nothing compelling in this circumstance which would warrant any compensation being made to the landlord under the Incentive Deed.”
As a result of the court’s judgment, the landlord was left only to pursue the tenant and the guarantors for damages arising from the tenant’s breach of the lease.
Implications for landlords and their agents
Lease incentive clawbacks by landlords, whether in the lease or in an incentive deed or other document, are unlikely to be enforced by the court.
Landlords and their agents should consider carefully the type and extent of incentives offered during lease negotiations. In particular, landlords should avoid the temptation to overreach in the leases they offer to their tenants.
A lease already enables a landlord to pursue the tenant and the guarantors for damages arising from the tenant’s breach of the lease. Adding lease incentive repayment clauses to the lease or to other documents can potentially lead to at least two negative outcomes.
The first is that the landlord basks in the delusion that the tenant can be contractually forced to repay the lease incentives. And secondly, it can lead to protracted and expensive legal proceedings that the landlord is likely to lose.
An experienced lawyer can draft a lease that avoids these pitfalls, while still allowing the landlord to offer the tenant lease incentives. One simple example is offering a rent-free period (or reduced rent) at the end of a lease, rather than at the beginning.